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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
--------------
- OR -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission Name of Registrants, State of Incorporation, I.R.S. Employer
File Number Address and Telephone Number Identification No.
- ----------- -------------------------------------------- ------------------
333-32170 PNM Resources, Inc. 85-0468296
(A New Mexico Corporation)
Alvarado Square
Albuquerque, New Mexico 87158
(505) 241-2700
1-6986 Public Service Company of New Mexico 85-0019030
(A New Mexico Corporation)
Alvarado Square
Albuquerque, New Mexico 87158
(505) 241-2700
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Name of Registrant Title of Each Class on Which Registered
- ------------------ ------------------- ---------------------
PNM Resources, Inc. Common Stock, No Par Value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act
None.
Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
------- -------
Indicate by check mark whether the registrants are accelerated filers (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
------- -------
As of May 1, 2003, 39,117,799 shares of common stock, no par value per
share, of PNM Resources, Inc. were outstanding.
PNM RESOURCES, INC. AND SUBSIDIARIES
INDEX
Page No.
PART I. FINANCIAL INFORMATION:
Report of Independent Public Accountants............................... 3
ITEM 1. FINANCIAL STATEMENTS
PNM Resources, Inc.
Consolidated Statements of Earnings
Three Months Ended March 31, 2003 and 2002.................. 5
Consolidated Balance Sheets
As of March 31, 2003 and December 31, 2002.................. 6
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2003 and 2002.................. 8
Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2003 and 2002.................. 9
Public Service Company of New Mexico
Consolidated Statements of Earnings
Three Months Ended March 31, 2003 and 2002.................. 10
Consolidated Balance Sheets
As of March 31, 2003 and December 31, 2002.................. 11
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2003 and 2002.................. 13
Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2003 and 2002.................. 14
Notes to Consolidated Financial Statements.......................... 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............. 33
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK................................................ 53
ITEM 4. CONTROLS AND PROCEDURES....................................... 61
PART II. OTHER INFORMATION:
ITEM 1. LEGAL PROCEEDINGS............................................. 61
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.............................. 63
Signature................................................................. 64
Certifications............................................................ 65
2
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of PNM Resources, Inc.
Albuquerque, New Mexico
We have reviewed the accompanying consolidated balance sheet of PNM Resources,
Inc. and subsidiaries (the Company) as of March 31, 2003, and the related
consolidated statements of earnings, cash flows, and comprehensive income for
the three-month periods ended March 31, 2003 and 2002. These financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
adopted SFAS 143, "Accounting for Asset Retirement Obligations," effective
January 1, 2003.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheets and
consolidated statements of capitalization (not presented herein) of PNM
Resources, Inc. and subsidiaries as of December 31, 2002, and the related
consolidated statements of earnings, retained earnings, comprehensive income
(loss), and cash flows for the year then ended (not presented herein); and in
our report dated February 11, 2003, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying consolidated balance sheet as of December 31, 2002 is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
DELOITTE & TOUCHE LLP
Omaha, Nebraska
May 9, 2003
3
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of Public Service Company of
New Mexico
Albuquerque, New Mexico
We have reviewed the accompanying consolidated balance sheet of Public Service
Company of New Mexico and subsidiaries (the Company) as of March 31, 2003, and
the related consolidated statements of earnings, cash flows, and comprehensive
income for the three-month periods ended March 31, 2003 and 2002. These
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
adopted SFAS 143, "Accounting for Asset Retirement Obligations," effective
January 1, 2003.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheets and
consolidated statements of capitalization (not presented herein) of Public
Service Company of New Mexico and subsidiaries as of December 31, 2002, and the
related consolidated statements of earnings, retained earnings, comprehensive
income (loss), and cash flows for the year then ended (not presented herein);
and in our report dated February 11, 2003, we expressed an unqualified opinion
on those consolidated financial statements. In our opinion, the information set
forth in the accompanying consolidated balance sheet as of December 31, 2002 is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Omaha, Nebraska
May 9, 2003
4
ITEM 1. FINANCIAL STATEMENTS
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended
March 31,
-------------------------------
2003 2002
--------------- --------------
(In thousands, except
per share amounts)
Operating Revenues:
Electric......................................................... $241,378 $191,961
Gas.............................................................. 146,253 109,201
Unregulated businesses........................................... 60 655
--------------- --------------
Total operating revenues....................................... 387,691 301,817
--------------- --------------
Operating Expenses:
Cost of energy sold.............................................. 225,934 143,605
Energy production costs.......................................... 35,094 34,971
Administrative and general....................................... 32,042 31,388
Depreciation and amortization.................................... 28,374 24,779
Transmission and distribution costs.............................. 16,159 16,537
Taxes other than income taxes.................................... 7,786 8,484
Income taxes..................................................... 8,876 9,366
--------------- --------------
Total operating expenses....................................... 354,265 269,130
--------------- --------------
Operating income............................................... 33,426 32,687
--------------- --------------
Other Income and Deductions:
Other income..................................................... 11,206 13,727
Other deductions................................................. (17,912) (1,497)
Income tax benefit (expense)..................................... 2,407 (4,842)
--------------- --------------
Net other income and (deductions).............................. (4,299) 7,388
--------------- --------------
Income before interest charges................................. 29,127 40,075
--------------- --------------
Interest Charges................................................... 18,233 15,126
--------------- --------------
Net Earnings from Operations....................................... 10,894 24,949
Cumulative Effect of a Change in Accounting Principle, Net of Tax.. 37,422 -
--------------- --------------
Net Earnings....................................................... 48,316 24,949
Preferred Stock Dividend Requirements.............................. 146 146
--------------- --------------
Net Earnings Applicable to Common Stock............................ $ 48,170 $ 24,803
=============== ==============
Net Earnings per Common Share:
Basic............................................................ $ 1.23 $ 0.63
=============== ==============
Diluted.......................................................... $ 1.22 $ 0.63
=============== ==============
Dividends Paid per Common Share.................................... $ 0.22 $ 0.20
=============== ==============
The accompanying notes are an integral part of these
financial statements.
5
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
-------------- --------------
2003 2002
-------------- --------------
(Unaudited)
(In thousands)
ASSETS
Utility Plant:
Electric plant in service........................................... $2,321,512 $2,301,673
Gas plant in service................................................ 619,332 615,907
Common plant in service and plant held for future use............... 86,359 79,987
-------------- --------------
3,027,203 2,997,567
Less accumulated depreciation and amortization...................... 1,312,620 1,330,376
-------------- --------------
1,714,583 1,667,191
Construction work in progress....................................... 174,477 173,248
Nuclear fuel, net of accumulated amortization of
$19,318 and $16,568............................................. 28,674 26,832
-------------- --------------
Net utility plant................................................. 1,917,734 1,867,271
-------------- --------------
Other Property and Investments:
Other investments................................................... 440,167 442,704
Non-utility property, net of accumulated depreciation of
$1,793 and $1,750............................................... 1,486 1,528
-------------- --------------
Total other property and investments.............................. 441,653 444,232
-------------- --------------
Current Assets:
Cash and cash equivalents........................................... 53,353 3,702
Accounts receivables, net of allowance for uncollectible
accounts of $13,583 and $15,575................................. 85,192 46,914
Unbilled revenues................................................... 50,502 65,472
Other receivables................................................... 41,647 53,052
Inventories......................................................... 37,711 37,230
Regulatory assets................................................... 22,721 24,027
Short-term investments.............................................. 847 79,630
Other current assets................................................ 55,741 32,753
-------------- --------------
Total current assets.............................................. 347,714 342,780
-------------- --------------
Deferred Charges:
Regulatory assets................................................... 182,079 196,283
Prepaid benefit costs............................................... 58,862 39,665
Other deferred charges.............................................. 133,094 129,063
-------------- --------------
Total deferred charges............................................ 374,035 365,011
-------------- --------------
$3,081,136 $3,019,294
============== ==============
The accompanying notes are an integral part of these
financial statements.
6
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
-------------- --------------
(Unaudited)
CAPITALIZATION AND LIABILITIES (In thousands)
Capitalization
Common stockholders' equity:
Common stock..................................................... $ 623,883 $ 624,119
Accumulated other comprehensive income (loss), net of tax........ (96,973) (94,721)
Retained earnings................................................ 483,826 444,651
-------------- --------------
Total common stockholders' equity............................. 1,010,736 974,049
Minority interest................................................... 11,221 11,760
Cumulative preferred stock without mandatory
redemption requirements........................................ 12,800 12,800
Long-term debt, less current maturities............................. 980,106 980,092
-------------- --------------
Total capitalization.......................................... 2,014,863 1,978,701
-------------- --------------
Current Liabilities:
Short-term debt...................................................... 170,000 150,000
Accounts payable...................................................... 75,008 90,355
Accrued interest and taxes............................................ 67,354 46,189
Other current liabilities............................................. 93,856 99,019
-------------- --------------
Total current liabilities..................................... 406,218 385,563
-------------- --------------
Deferred Credits:
Accumulated deferred income taxes..................................... 141,780 125,595
Accumulated deferred investment tax credits........................... 40,803 41,583
Regulatory liabilities................................................ 75,626 52,019
Regulatory liabilities related to accumulated deferred income tax..... 14,137 14,137
Asset retirement obligations.......................................... 43,098 -
Accrued post-retirement benefit costs................................. 16,836 17,335
Other deferred credits................................................ 327,775 404,361
-------------- --------------
Total deferred credits......................................... 660,055 655,030
-------------- --------------
$3,081,136 $3,019,294
============== ==============
The accompanying notes are an integral part of these
financial statements.
7
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
-------------------------------
2003 2002
-------------- --------------
(In thousands)
Cash Flows From Operating Activities:
Net earnings............................................................. $ 48,316 $ 24,949
Adjustments to reconcile net earnings to net cash flows
from operating activities:
Depreciation and amortization......................................... 32,660 27,995
Accumulated deferred income tax....................................... 17,028 (2,324)
Transition costs write-off............................................ 16,720 -
Cumulative effect of a change in accounting principle................. (61,946) -
Net unrealized losses (gains) on trading and investing contracts...... 418 (9,510)
Changes in certain assets and liabilities:
Accounts receivable................................................... (38,278) (85)
Unbilled revenues..................................................... 14,970 18,218
Accrued post-retirement benefit costs................................. (19,696) (22,647)
Other assets.......................................................... 11,088 12,624
Accounts payable...................................................... (15,347) 9,516
Accrued interest and taxes............................................ 21,166 (18,972)
Other liabilities..................................................... (20,752) (26,747)
-------------- --------------
Net cash flows provided by operating activities..................... 6,347 13,017
-------------- --------------
Cash Flows From Investing Activities:
Sale of short-term investments........................................... 79,444 -
Utility plant additions.................................................. (35,268) (61,627)
Combustion turbine payments.............................................. (11,136) (7,845)
Return of principal of PVNGS lessor notes................................ 9,406 8,996
EIP bond purchase........................................................ (7,355) -
Other investing.......................................................... (2,274) (2,003)
-------------- --------------
Net cash flows provided by (used for) investing activities.......... 32,817 (62,479)
-------------- --------------
Cash Flows From Financing Activities:
Borrowings............................................................... 20,000 58,800
Exercise of employee stock options....................................... (235) (2,483)
Dividends paid........................................................... (8,750) (7,969)
Other financing.......................................................... (528) (586)
-------------- --------------
Net cash flows provided by financing activities..................... 10,487 47,762
-------------- --------------
Increase in Cash and Cash Equivalents...................................... 49,651 (1,700)
Beginning of Period........................................................ 3,702 28,408
-------------- --------------
End of Period.............................................................. $ 53,353 $ 26,708
============== ==============
Supplemental Cash Flow Disclosures:
Interest paid............................................................ $ 19,866 $ 16,183
============== ==============
Capitalized interest..................................................... $ 114 $ 1,740
============== ==============
Income taxes paid, net................................................... $ (4,152) $ 38,283
============== ==============
The accompanying notes are an integral part of these
financial statements.
8
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended
March 31,
-----------------------------
2003 2002
-----------------------------
(In thousands)
Net Earnings before preferred stock dividends............................ $ 48,316 $24,949
------------- --------------
Other Comprehensive Income, net of tax:
Unrealized gain (loss) on securities:
Unrealized holding gains (losses) arising from the period.......... (580) 1,822
Reclassification adjustment for (gains) losses
included in net income.......................................... (465) (430)
Mark-to-market adjustment for certain derivative transactions:
Change in fair market value of designated cash flow hedges......... (1,207) 615
Reclassification adjustment for (gains) losses
in cash flow hedges............................................. - 568
------------- --------------
Total Other Comprehensive Income (Loss).................................. (2,252) 2,575
------------- --------------
Total Comprehensive Income............................................... $46,064 $27,524
============= ==============
The accompanying notes are an integral part of these
financial statements.
9
PUBLIC SERVICE COMPANY OF NEW MEXICO
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended
March 31,
------------------------------
2003 2002
-------------- -------------
(In thousands, except
per share amounts)
Operating Revenues:
Electric........................................................ $241,378 $191,961
Gas............................................................. 146,253 109,201
-------------- -------------
Total operating revenues...................................... 387,631 301,162
-------------- -------------
Operating Expenses:
Cost of energy sold............................................. 225,934 143,106
Energy production costs......................................... 35,094 34,971
Administrative and general...................................... 32,759 27,825
Depreciation and amortization................................... 27,933 24,773
Transmission and distribution costs............................. 17,259 16,537
Taxes, other than income taxes.................................. 8,701 8,036
Income taxes.................................................... 8,201 9,772
-------------- -------------
Total operating expenses...................................... 355,881 265,020
-------------- -------------
Operating income.............................................. 31,750 36,142
-------------- -------------
Other Income and Deductions:
Other income.................................................... 10,493 10,365
Other deductions................................................ (18,481) (2,126)
Income tax benefit (expense).................................... 2,914 (4,373)
-------------- -------------
Net other income and (deductions)............................. (5,074) 3,866
-------------- -------------
Income before interest charges................................ 26,676 40,008
-------------- -------------
Interest charges.................................................. 17,587 15,154
-------------- -------------
Net Earnings from Operations...................................... 9,089 24,854
-------------- -------------
Cumulative Effect of a Change in Accounting Principle, Net of Tax. 37,422 -
-------------- -------------
Net Earnings Before Preferred Stock Dividends..................... 46,511 24,854
Preferred Stock Dividend Requirements............................. 146 146
-------------- -------------
Net Earnings...................................................... $ 46,365 $ 24,708
============== =============
The accompanying notes are an integral part of these
financial statements.
10
PUBLIC SERVICE COMPANY OF NEW MEXICO
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
-------------- --------------
(Unaudited)
(In thousands)
ASSETS
Utility Plant:
Electric plant in service......................................... $ 2,321,512 $ 2,301,048
Gas plant in service.............................................. 619,332 615,907
Common plant in service and plant held for future use............. 22,102 18,137
-------------- --------------
2,962,946 2,935,092
Less accumulated depreciation and amortization.................... 1,304,145 1,326,286
-------------- --------------
1,658,801 1,608,806
Construction work in progress..................................... 161,607 159,435
Nuclear fuel, net of accumulated amortization of
$19,318 and $16,568........................................... 28,674 26,832
-------------- --------------
Net utility plant............................................... 1,849,082 1,795,073
-------------- --------------
Other Property and Investments:
Other investments................................................. 418,475 428,823
Non-utility property.............................................. 966 966
-------------- --------------
Total other property and investments............................ 419,441 429,789
-------------- --------------
urrent Assets:
Cash and cash equivalents......................................... 38,996 3,094
Accounts receivables, net of allowance for uncollectible
accounts of $13,583 and $15,575............................... 85,193 46,914
Unbilled revenues................................................. 50,502 65,472
Other receivables................................................. 39,182 52,783
Intercompany receivable........................................... - 4,593
Inventories....................................................... 37,709 37,228
Regulatory assets................................................. 22,720 24,027
Other current assets.............................................. 45,634 22,872
-------------- --------------
Total current assets............................................ 319,936 256,983
-------------- --------------
Deferred Charges:
Regulatory assets................................................. 182,079 196,242
Prepaid benefit costs............................................. 58,862 39,665
Other deferred charges............................................ 132,935 129,083
-------------- --------------
Total current assets............................................ 373,876 364,990
-------------- --------------
$ 2,962,335 $ 2,846,835
============== ==============
The accompanying notes are an integral part of these
financial statements.
11
PUBLIC SERVICE COMPANY OF NEW MEXICO
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
-------------- --------------
(Unaudited)
CAPITALIZATION AND LIABILITIES (In thousands)
Capitalization:
Common stockholder's equity:
Common stock...................................................... $ 195,589 $ 195,589
Additional paid-in capital........................................ 505,044 430,043
Accumulated other comprehensive income (loss), net of tax......... (95,395) (94,130)
Retained earnings................................................. 302,523 256,157
-------------- --------------
Total common stockholder's equity.............................. 907,761 787,659
Minority interest.................................................... 11,221 11,760
Cumulative preferred stock without mandatory
redemption requirements......................................... 12,800 12,800
Long-term debt, less current maturities.............................. 953,954 953,940
-------------- --------------
Total capitalization........................................... 1,885,736 1,766,159
-------------- --------------
Current Liabilities:
Short-term debt...................................................... 170,000 150,000
Intercompany debt.................................................... 17,037 28,436
Accounts payable..................................................... 73,799 88,101
Intercompany accounts payable........................................ 15,817 34,468
Accrued interest and taxes........................................... 56,051 36,450
Other current liabilities............................................ 82,459 87,701
-------------- --------------
Total current liabilities...................................... 415,163 425,156
-------------- --------------
Deferred Credits:
Accumulated deferred income taxes...................................... 145,216 128,383
Accumulated deferred investment tax credits............................ 40,803 41,583
Asset retirement obligation............................................ 43,098 -
Regulatory liabilities................................................. 75,626 52,019
Regulatory liabilities related to accumulated deferred income tax...... 14,137 14,137
Accrued post-retirement benefit costs.................................. 17,067 17,335
Other deferred credits................................................. 325,489 402,063
-------------- --------------
Total deferred credits.............................................. 661,436 655,520
-------------- --------------
$ 2,962,335 $ 2,846,835
============== ==============
The accompanying notes are an integral part of these
financial statements.
12
PUBLIC SERVICE COMPANY OF NEW MEXICO
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
------------------------
2003 2002
----------- -----------
(In thousands)
Cash Flows From Operating Activities:
Net earnings.......................................................... $ 46,511 $ 24,854
Adjustments to reconcile net earnings to net cash flows
from operating activities:
Depreciation and amortization...................................... 32,219 27,948
Accumulated deferred income tax.................................... 17,027 (2,974)
Transition costs write-off......................................... 16,720 -
Cumulative effect of a change in accounting principle.............. (61,946) -
Net unrealized losses on trading and investments contracts......... 418 (9,510)
Changes in certain assets and liabilities:
Accounts receivable................................................ (38,279) (85)
Unbilled revenues.................................................. 14,970 18,218
Accrued post-retirement benefit costs.............................. (19,696) (21,767)
Other assets....................................................... 9,445 (16,505)
Accounts payable................................................... (14,302) 1,581
Accrued interest and taxes......................................... 23,140 (11,401)
Other liabilities.................................................. (23,987) (25,877)
----------- -----------
Net cash flows provided by (used for) operating activities....... 2,240 (15,518)
----------- -----------
Cash Flows From Investing Activities:
Utility plant additions............................................... (34,192) (60,151)
Combustion turbine payments........................................... (11,136) (7,845)
Return of principal of PVNGS lessor notes............................. 9,406 8,996
Other investing....................................................... 479 4,321
----------- -----------
Net cash flows used for investing activities..................... (35,443) (54,679)
----------- -----------
Cash Flows From Financing Activities:
Borrowings............................................................ 20,000 58,800
Equity contribution from parent....................................... 75,000 -
Dividends paid........................................................ (147) (34,421)
Other financing....................................................... (523) (585)
Change in intercompany accounts....................................... (25,225) 52,383
----------- -----------
Net cash flows provided by financing activities.................. 69,105 76,177
----------- -----------
Increase in Cash and Cash Equivalents................................. 35,902 5,980
Beginning of Period................................................... 3,094 17,028
----------- -----------
End of Period......................................................... $ 38,996 $ 23,008
=========== ===========
Supplemental Cash Flow Disclosures:
Interest paid......................................................... $ 21,133 $ 16,183
=========== ===========
Capitalized interest.................................................. $ 114 $ 1,740
=========== ===========
Income taxes paid, net................................................ $ (4,093) $ 31,514
=========== ===========
The accompanying notes are an integral part of these
financial statements.
13
PUBLIC SERVICE COMPANY OF NEW MEXICO
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended
March 31,
-----------------------------
2003 2002
------------- --------------
(In thousands)
Net Earnings Before Preferred Stock Dividends............................. $46,511 $24,854
------------- --------------
Other Comprehensive Income, net of tax:
Unrealized gain (loss) on securities:
Unrealized holding gains (losses) arising from the period........... (44) 1,383
Reclassification adjustment for (gains) losses
included in net income........................................... (14) (430)
Mark-to-market adjustment for certain derivative transactions:
Change in fair market value of designated cash flow hedges.......... (1,207) 615
Reclassification adjustment for (gains) losses
in cash flow hedges.............................................. - 568
------------- --------------
Total Other Comprehensive Income (Loss)................................... (1,265) 2,136
------------- --------------
Total Comprehensive Income................................................ $45,246 $26,990
============= ==============
The accompanying notes are an integral part of these
financial statements.
14
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Accounting Policies and Responsibility for Financial Statements
In the opinion of the management of PNM Resources, Inc. (the "Holding
Company") and Public Service Company of New Mexico ("PNM"), (collectively, the
"Company") the accompanying interim consolidated financial statements present
fairly the Company's financial position at March 31, 2003 and December 31, 2002,
the consolidated results of its operations for the three months ended March 31,
2003 and 2002 and the consolidated statements of cash flows and comprehensive
income for the three months ended March 31, 2003 and 2002. These statements are
presented in accordance with the rules and regulations of the United States
Securities and Exchange Commission ("SEC"). Accordingly, they are unaudited, and
certain information and footnote disclosures normally included in the Company's
annual consolidated financial statements have been condensed or omitted, as
permitted under the applicable rules and regulations. Readers of these financial
statements should refer to the Company's audited consolidated financial
statements and notes thereto for the year ended December 31, 2002, that are
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002. The results of operations presented in the accompanying financial
statements are not necessarily representative of operations for an entire year.
Presentation
The Notes to Consolidated Financial Statements of the Company are
presented on a combined basis. The business of PNM constitutes substantially all
of the business of PNM Resources, Inc. and Subsidiaries. Therefore, the
financial results and results of operations of PNM are virtually identical to
the consolidated results of the Holding Company and all its subsidiaries. For
discussion purposes, this report will use the term "Company" when discussing
matters of common applicability to the Holding Company and PNM. Readers of the
Notes to Consolidated Financial Statements should assume that the information
presented applies to the consolidated results of operations and financial
position of both the Holding Company and its subsidiaries and PNM, except where
the context or references clearly indicate otherwise. In the case of contractual
obligations of PNM, these obligations are consolidated with the Holding Company
and its subsidiaries under generally accepted accounting principles ("GAAP").
Broader operational discussions refer to the Company.
Certain amounts in the 2002 consolidated financial statements and notes
have been reclassified to conform to the 2003 financial statement presentation.
Regulatory Accounting
The Company's accounting policies conform to the provisions of Statement
of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" ("SFAS 71"). SFAS 71 requires a rate-regulated entity to
reflect the effects of regulatory decisions in its financial statements. In
accordance with SFAS 71, the Company has deferred certain costs and recorded
certain liabilities pursuant to the rate actions of the Federal Energy
Regulatory Commission ("FERC"), and the New Mexico Public Regulation Commission
("PRC") and its predecessor. To the extent that the Company concludes that the
15
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
recovery of a regulatory asset is no longer probable due to regulatory
treatment, the effects of competition or other factors, the amount would be
recorded as a charge to earnings in the period in which recovery is determined
to no longer be probable.
As of December 31, 1999, the Company discontinued the application of SFAS
71 for the generation portion of its business effective with the passage of the
Electric Utility Industry Restructuring Act of 1999 ("Restructuring Act") in
accordance with Statement of Financial Accounting Standards No. 101, "Accounting
for the Discontinuation of Application of the Financial Accounting Standards
Board ("FASB") FASB Statement No. 71" ("SFAS 101"). As a result of the repeal of
the Restructuring Act (see Note 5 - "Commitments and Contingencies - Global
Electric Agreement"), the Company re-applied the accounting requirements of SFAS
71 to the generation portion of its business as of January 28, 2003.
Asset Retirement Obligations
In June 2001, Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations" ("SFAS 143") was issued. SFAS 143
requires the recognition and measurement of liabilities associated with the
retirement of tangible long-lived assets that result from the acquisition,
construction or development, and or normal operations of long-lived assets.
Retirement obligations associated with long-lived assets included within the
scope of SFAS 143 are those for which a legal obligation exists under enacted
laws, statutes, written or oral contracts, including obligations arising under
the doctrine of promissory estoppel. Under the standard, the asset retirement
obligation ("ARO") liability is recognized at its fair value as incurred.
The recognition of an ARO results in an increase in the carrying cost of
the long-lived asset, which will be amortized using a systematic and rational
basis over the remaining life of the related asset as depreciation expense. An
ARO represents a future liability and, as a result, accretion expense will be
accrued on this liability until such time as the obligation is satisfied.
Accretion of the ARO liability due to the passage of time is recorded as an
operating expense. If at the end of the asset's life the recorded liability
differs from the actual settled obligation, the Company may incur a gain or loss
that will be recognized at that time.
The Company adopted the provisions of the statement on January 1, 2003
and accordingly identified certain AROs that are subject to the standard. These
obligations included the decommissioning of the Company's nuclear generation
facilities and fossil fuel generation plants. The Company's transmission and
distribution facilities are also subject to the standard; however, the majority
of these assets have an indeterminable useful life and settlement date. As such,
an ARO liability for transmission and distribution assets would not be
recognized until this information becomes known and is material. The Company did
not identify any material AROs associated with the transmission and distribution
assets.
Previously, the Company had recognized decommissioning costs for its
fossil fuel and nuclear generation facilities ratably over approved cost
recovery periods. Upon implementation of the standard the net difference between
16
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
the amounts determined to represent legal AROs under SFAS 143 and the Company's
previous method of accounting for decommissioning costs, has been recognized as
a cumulative effect of a change in accounting principle, net of related income
taxes. Additionally, certain amounts accrued for nuclear decommissioning costs
over the Company's legal AROs for its nuclear generation facilities have been
reclassified as regulatory liabilities.
The effects of adoption of the new standard are based on the Company's
interpretation of the standard and determination of underlying assumptions, such
as the Company's discount rate, estimates of the future costs for
decommissioning and the timing of the removal activities to be performed. Any
changes in these assumptions underlying the required calculations may require
revisions to the estimated ARO when identified.
The following table shows the pro forma effect on the Company's earnings
had the Company adopted SFAS 143 at the beginning of each respective period. The
pro forma amounts below are based on current information and assumptions, which
are reflected in the consolidated statement of earnings. The following table is
presented for comparative purposes.
Three Months
Ended Year Ended
March 31, December 31,
2002 2002 2001 2000
------------ ----------- ----------- -----------
(In thousands)
Net earnings before cumulative effect of a
change in accounting principle.................... $ 24,803 $63,685 $149,847 $100,360
Cumulative effect of a change in accounting
principle......................................... 32,771 37,422 32,771 28,059
------------ ----------- ----------- -----------
Net earnings applicable to common stock............. $ 57,574 $101,107 $182,618 $128,419
============ =========== =========== ===========
Earnings per share:
Net earnings before cumulative effect of a
change in accounting principle.................... $ 0.63 $ 1.63 $ 3.83 $ 2.54
Cumulative effect of a change in accounting
principle......................................... 0.84 0.95 0.84 0.71
------------ ----------- ----------- -----------
Net earnings applicable to common stock............. $ 1.47 $ 2.58 $ 4.67 $ 3.25
============ =========== =========== ===========
Diluted earnings per share before cumulative
effect of a change in accounting principle........ $ 0.63 $ 1.61 $ 3.77 $ 2.53
============ =========== =========== ===========
Diluted earnings per share after cumulative
effect of a change in accounting principle........ $ 1.45 $ 2.56 $ 4.60 $ 3.23
============ =========== =========== ===========
Asset retirement obligation liability............... $42,201 $38,235
=========== ===========
17
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A reconciliation of the Company's asset retirement obligations is as
follows:
March 31, 2003
--------------
(In thousands)
Upon adoption at January 1, 2003...................... $42,201
Liabilities incurred.................................. -
Liabilities settled................................... -
Accretion expense..................................... 897
Revisions to estimate................................. -
--------------
$43,098
==============
Stock Options
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." Compensation cost for stock options,
if any, is measured as the excess of the quoted market price of the Company's
stock at the date of grant over the exercise price of the granted stock option.
Restricted stock is recorded as compensation cost over the requisite vesting
periods based on the market value on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"),
established accounting and disclosure requirements using a fair-value-based
method of accounting for stock-based employee compensation plans. The Company
has elected to retain its current method of accounting as described above, and
has adopted the disclosure requirements of SFAS 123 only.
(Intentionally left blank)
18
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
At March 31, 2003, the Company had three stock-based employee
compensation plans. Options continue to be granted under only two of these
plans. Had compensation expense for the Company's stock options been recognized
based on the fair value on the grant date under the methodology prescribed by
SFAS 123, the effect on the Company's pro forma net earnings and pro forma
earnings per share would be as follows (in thousands, except per share data):
Three Months Ended
March 31,
---------------------------
2003 2002
------------- ------------
Net earnings: (available for common)........... $ 48,170 $ 24,803
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects.................. (505) (1,106)
------------- ------------
Pro forma net earnings......................... $ 47,665 $ 23,697
============= ============
Earnings per share:
Basic - as reported........................ $ 1.23 $ 0.63
============= ============
Basic - pro forma.......................... $ 1.22 $ 0.61
============= ============
Diluted - as reported...................... $ 1.22 $ 0.63
============= ============
Diluted - pro forma........................ $ 1.21 $ 0.60
============= ============
(2) Segment Information
The Holding Company is an investor-owned holding company of energy and
energy related businesses. Its principal subsidiary, PNM, is an integrated
public utility primarily engaged in the generation, transmission, distribution
and sale and marketing of electricity; transmission, distribution and sale of
natural gas within the State of New Mexico and the sale and marketing of
electricity in the Western United States. In addition, the Holding Company
provides energy and technology related services through its wholly-owned
subsidiary, Avistar Inc. ("Avistar").
As it currently operates, the Company's principal business segments are
Utility Operations and Wholesale Operations ("Wholesale"). Utility Operations
include Electric Services ("Electric"), Transmission Services ("Transmission")
and Gas Services ("Gas"). These segments model the resource allocations as
mandated in the Global Electric Agreement (see Note 6 - Global Electric
Agreement). Certain prior period amounts have been reclassified to conform to
the current year presentation.
19
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
UTILITY OPERATIONS
Electric
Electric consists of the distribution and generation of electricity for
retail electric customers in New Mexico. The Company provides retail electric
service to a large area of north central New Mexico, including the cities of
Albuquerque and Santa Fe, and certain other areas of New Mexico. Customer rates
for retail electric service are set by the PRC based on the provisions of the
Global Electric Agreement.
Transmission
The Company owns or leases transmission lines, interconnected with other
utilities in New Mexico and south and east into Texas, west into Arizona, and
north into Colorado and Utah. Transmission revenues consist of sales to third
parties as well as to Electric and Wholesale.
Gas
The Company's Gas Services distribute natural gas to most of the major
communities in New Mexico, including New Mexico's two largest metropolitan
areas, Albuquerque and Santa Fe. The Company's customer base includes both
sales-service customers and transportation-service customers. PNM purchases
natural gas in the open market and resells it at cost to its distribution
customers. As a result, increases or decreases in gas revenues driven by
wholesale gas prices do not impact the Company's consolidated gross margin or
earnings.
WHOLESALE OPERATIONS
The Company's Wholesale Operations consists of three product lines that
include long-term contracts, forward sales and short-term sales. Long-term
contracts include sales to firm-requirements wholesale customers with multi-year
arrangements. These contracts range from 2 to 17 years with an average of 7.5
years. Forward sales include sales of excess generation and third party
purchases in the forward market that range from 1 month to 3 years. These
transactions do not qualify as normal sales and purchases as defined in SFAS 133
and as a result, are generally marked to market. Short-term sales generally
include spot market, hour ahead, day ahead and week ahead contracts with terms
of 30 days or less. Also included are sales of any excess generation not
required to fulfill PNM's retail load and contractual commitments. Short-term
sales also cover the revenue credit to retail customers as specified in the
Global Electric Agreement. While forward sales and short-term sales accounted
for approximately 58% of wholesale revenues for the three months ended March 31,
2003, long-term contracts provided approximately 97% of gross margin.
20
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CORPORATE AND OTHER
The Holding Company incurs substantially all of the corporate activities
of PNM. These activities are billed to PNM on a cost basis to the extent they
are for the corporate management of PNM and are allocated to the operating
segments. The Holding Company's wholly-owned subsidiary, Avistar, was formed in
August 1999 as a New Mexico corporation and is currently engaged in certain
unregulated and non-utility businesses. In January 2002, Avistar was transferred
by way of a dividend to the Holding Company pursuant to an order from the PRC.
RISKS AND UNCERTAINTIES
The Company's future results may be affected by changes in regional
economic conditions; the outcome of labor negotiations with unionized employees;
fluctuations in fuel, purchased power and gas prices; the actions of utility
regulatory commissions; changes in law and environmental regulations; the
success of its planned generation expansion; and external factors such as the
weather and water supply. As a result of pending federal regulatory reforms, the
public utility industry is undergoing a fundamental change. New Mexico has
repealed the Electric Utility Industry Restructuring Act of 1999 and therefore
has abandoned its plans to transform the industry from vertically-integrated
monopoly to one with deregulated, competitive generation. However, the FERC has
proposed a "Standard Market Design" ("SMD") to establish rules for a
market-based approach for wholesale transactions over the transmission grid.
FERC's efforts have been opposed by a number of states, primarily in the West
and in the Southeast, because of concern that the SMD does not adequately take
into account regional differences. Congress is currently debating energy
legislation which could affect FERC's activities. In an attempt to ease
concerns, on April 28, 2003, FERC issued a White Paper on "Wholesale Power
Market Platform" describing changes it intended to make to its SMD proposed
rules. The Company's future results will be impacted by the form FERC rules
take, if adopted; the costs of complying with rules and legislation that may
call for regulatory reforms for the industry; and the resulting market prices
for electricity and natural gas. In addition, the Company has in place a retail
electric rate freeze through 2007 so that the Company's financial results will
depend on its ability to control costs and grow revenues, and the implications
of uncontrollable factors such as weather, water supply, litigation, and
economic conditions.
(Intentionally left blank)
21
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Summarized financial information by business segment for the three months
ended March 31, 2003 and 2002 is as follows:
Utility
--------------------------------- Corporate
Electric Gas Total Wholesale and Other Consolidated
---------- ----------- ---------- ---------- ---------- ------------
(In thousands)
2003:
Operating revenues..................... $133,600 $ 146,253 $ 279,853 $107,778 $ 60 $ 387,691
Depreciation and amortization.......... 18,057 5,442 23,499 3,491 1,384 28,374
Interest income........................ 788 777 1,565 120 9,015 10,700
Interest charges....................... 8,485 3,135 11,620 1,193 5,420 18,233
Income tax expense (benefit)
from operations...................... (430 4,412 3,982 1,070 1,417 6,469
Operating income....................... 18,010 9,396 27,406 2,795 3,225 33,426
Cumulative effect of a change
in accounting principle, net of tax.. 25,093 - 25,093 12,329 - 37,422
Segment net income (loss).............. 28,591 6,733 35,324 14,649 (1,657) 48,316
Total assets........................... 1,558,340 481,972 2,040,312 413,411 627,413 3,081,136
Gross property additions............... 23,235 7,221 30,456 14,872 1,076 46,404
Utility
--------------------------------- Corporate
Electric Gas Total Wholesale and Other Consolidated
---------- ----------- ---------- ---------- ---------- ------------
(In thousands)
2002:
Operating revenues..................... $135,419 $ 109,201 $ 244,620 $ 56,542 $ 655 $ 301,817
Depreciation and amortization.......... 17,008 5,062 22,070 1,856 853 24,779
Interest income........................ 664 88 752 56 11,024 11,832
Interest charges....................... 8,268 3,318 11,586 1,035 2,505 15,126
Income tax expense (benefit)
from operations...................... 7,260 5,287 12,547 (921) 2,582 14,208
Operating income....................... 19,616 11,443 31,059 (346) 1,974 32,687
Segment net income (loss).............. 15,449 8,066 23,515 (665) 2,099 24,949
Total assets........................... 1,867,929 457,934 2,325,863 313,382 308,151 2,947,396
Gross property additions............... 53,572 6,543 60,115 7,881 1,476 69,472
(3) Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced sale or liquidation. Although management uses its best
judgment in estimating the fair value of these financial instruments, there are
inherent limitations in any estimation technique. Therefore, the fair value
estimates presented herein are not necessarily indicative of the amounts that
the Company could realize in a current transaction. Fair value is based on
market quotes provided by the Company's investment bankers and trust advisors.
22
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The amortized cost, gross unrealized gain and losses and estimated fair
value of investments in available-for-sale securities are as follows:
March 31, 2003
--------------------------------------------------------------------
Amortized Cost Unrealized Unrealized Fair Value
Gains Losses
---------------- ---------------- --------------- ----------------
(In thousands)
Available-for-sale:
Equity securities................ $ 37,974 $4,864 $ (2,286) $ 40,552
Municipal bonds.................. 17,861 1,364 - 19,225
U.S. Government securities....... 5,682 540 (8) 6,214
Corporate bonds.................. 11 1 - 12
Other investments................ 5,666 - - 5,666
---------------- ---------------- --------------- ----------------
$ 67,194 $6,769 $ (2,294) $ 71,669
================ ================ =============== ================
December 31, 2002
--------------------------------------------------------------------
Amortized Cost Unrealized Unrealized Fair Value
Gains Losses
---------------- ---------------- --------------- ----------------
(In thousands)
Available-for-sale:
Equity securities................ $32,643 $4,134 $ (1,514) $ 35,263
Mortgage-backed securities....... 33,145 410 (93) 33,462
Corporate bonds.................. 32,466 438 (19) 32,885
Municipal bonds.................. 21,229 1,394 (24) 22,599
U.S. Government securities....... 12,725 702 - 13,427
Other investments................ 14,716 - - 14,716
---------------- ---------------- --------------- ----------------
$146,924 $7,078 $ (1,650) $152,352
================ ================ =============== ================
(Intentionally left blank)
23
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
At March 31, 2003, the available-for-sale securities held by the Company
had the following maturities:
Amortized Cost Fair Value
---------------- ----------------
(In thousands)
Within 1 year............................. $ 846 $ 865
After 1 year through 5 years.............. 3,387 3,498
After 5 years through 10 years............ 2,736 2,889
Over 10 years............................. 16,585 18,199
Equity securities......................... 37,974 40,552
Other investments......................... 5,666 5,666
---------------- ----------------
$67,194 $71,669
================ ================
The proceeds and gross realized gains and losses on the disposition of
available-for-sale investments are shown in the following table. Realized gains
and losses are determined by specific identification.
Three Months Ended
March 31,
2003 2002
--------------- ----------------
(In thousands)
Proceeds from sales............ $86,844 $55,020
Gross realized gains........... 1,817 1,282
Gross realized losses.......... (1,621) (2,517)
Natural Gas Contracts
Pursuant to a 1997 order issued by the New Mexico Public Utility
Commission, predecessor to the PRC, the Company has previously entered into
swaps to hedge certain portions of natural gas supply contracts in order to
protect the Company's natural gas customers from the risk of adverse price
fluctuations in the natural gas market. The financial impact of all hedge gains
and losses from swaps is recoverable through the Company's purchased gas
adjustment clause ("PGAC") if deemed prudently incurred by the PRC. As a result,
earnings are not affected by gains or losses generated by these instruments.
PNM purchased gas options, a type of hedge, to protect its natural gas
customers from the risk of price fluctuations during the 2002-2003 heating
season. PNM expended $6.0 million to purchase options that limit the maximum
amount the Company would pay for gas during the winter heating season. The
Company recovered its actual hedging expenditures as a component of the PGAC
during the months of October 2002 through February 2003 in equal allotments of
$1.2 million.
24
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Electricity Contracts
The Company's Wholesale Operations entered into forward physical
contracts for the sale of the Company's electric capacity in excess of its
retail and wholesale firm requirement needs, including reserves. These contracts
are marked to market as required by Statement of Financial Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). For
the three months ended March 31, 2003, the Company's Wholesale Operations
settled forward contracts for the sale of electricity that generated $22.3
million of electric revenues by delivering 562.2 million MWh. The Company
purchased $22.3 million or 575.7 million MWh of electricity to support these
contractual sales and other open market sales opportunities. For the three
months ended March 31, 2002, the Company's Wholesale Operations settled forward
contracts for the sale of electricity that generated $7.8 million of electric
revenues by delivering 222.1 million MWh. The Company purchased $17 million or
276.9 million MWh of electricity to support these contractual sales and other
open market sales opportunities.
As of March 31, 2003, the Company had open contract positions to buy
$82.5 million and to sell $80.3 million of electricity. At March 31, 2003, the
Company had a gross mark-to-market gain (asset position) on these forward
contracts of $16.7 million and gross mark-to-market loss (liability position) of
$18.1 million, with net mark-to-market loss (liability position) of $1.34
million recorded in other current assets and liabilities, respectively. The
change in mark-to-market valuation is recognized in earnings each period
recorded in operating revenues.
In addition, the Company entered into forward physical contracts for the
purchase of retail needs, including reserves, when resource shortfalls exist.
The Company generally accounts for these derivative financial instruments as
normal sales and purchases as defined by SFAS 133, as amended. From time to time
the Company makes forward purchases to serve its retail needs when the cost of
purchased power is less than the incremental cost of its generation. At March
31, 2003, the Company had open forward positions classified as normal sales of
electricity of $121 million and normal purchases of electricity of $93 million
which are not recorded on the financial statements.
The Company's Wholesale Operations, including both firm commitments and
other wholesale sale activities, are managed through an asset-backed strategy,
whereby the Company's aggregate net open position is covered by its own excess
generation capabilities. The Company is exposed to market risk if its generation
capabilities were disrupted or if its retail load requirements were greater than
anticipated. If the Company were required to cover all or a portion of its net
open contract position, it would have to meet its commitments through market
purchases.
The Company is exposed to credit risk in the event of non-performance or
non-payment by counterparties of its financial derivative instruments. The
Company uses a credit management process to assess and monitor the financial
conditions of counterparties. The Company's credit risk with its largest
counterparty as of March 31, 2003 and December 31, 2002 was $20.2 million and
$18.7 million, respectively.
25
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Forward Starting Interest Rate Swaps
PNM currently has $46 million of tax-exempt bonds outstanding that were
callable at a premium beginning December 15, 2002, and an additional $136
million that become callable at a premium in August 2003. PNM intends to
refinance these bonds, assuming the interest rate of the refinancing does not
exceed the current interest rate of the bonds, and has hedged the entire planned
refinancing (see Note 9 - "Subsequent Events - Refinance of Pollution Control
Bonds"). The Company received regulatory approval to refund the tax-exempt bonds
on October 29, 2002. This approval is effective for one year. In order to take
advantage of current low interest rates, PNM entered into five forward starting
interest rate swaps in the fourth quarter of 2001 and the first quarter of 2002.
PNM designated these swaps as cash flow hedges. The hedged risks associated with
these instruments are the changes in cash flows related to general moves in
interest rates expected for the refinancing. The swaps effectively cap the
interest rate on the refinancing to 4.95% plus an adjustment for PNM's and the
industry's credit rating. PNM's assessment of hedge effectiveness is based on
changes in the hedge interest rates. The derivative accounting rules, as
amended, provide that the effective portion of the gain or loss on a derivative
instrument designated and qualifying as a cash flow hedging instrument be
reported as a component of other comprehensive income and be reclassified into
earnings in the same period or periods during which the hedged forecasted
transactions settle. Any hedge ineffectiveness is required to be presented in
current earnings. There was no material hedge ineffectiveness for the three
months ended March 31, 2003. At March 31, 2003, the fair market value of these
derivative financial instruments was approximately $21.0 million unfavorable to
the Company recorded in accumulated other comprehensive income (loss).
A forward starting swap does not require any upfront premium and captures
changes in the corporate credit component of an investment grade company's
interest rate as well as the underlying benchmark. The five forward starting
interest rate swaps have a termination date of May 15, 2003 for a combined
notional amount of $182.0 million. There were no fees on the transaction, as
they are imbedded in the rates, and the transaction will be cash settled on the
mandatory strike date, corresponding to the refinancing date of the underlying
debt. The settlement will be capitalized as a cost of issuance and amortized
over the life of the debt as a yield adjustment provided that the forecasted
transactions (interest payments) occur as anticipated.
(Intentionally left blank)
26
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(4) Earnings Per Share
In accordance with SFAS No. 128, Earnings per Share, dual presentation of
basic and diluted earnings per share has been presented in the Consolidated
Statements of Earnings. The following reconciliation illustrates the impact on
the share amounts of potential common shares and the earnings per share amounts
for March 31 (in thousands except per share amounts):
Three Months Ended
March 31,
2003 2002
----------- -----------
Basic:
Net Earnings from Operations............................ $ 10,894 $ 24,949
Cumulative effect of a change in accounting principle... 37,422 -
----------- -----------
Net Earnings............................................ 48,316 24,949
Preferred Stock Dividend Requirements................... 146 146
----------- -----------
Net Earnings Applicable to Common Stock................. $ 48,170 $ 24,803
=========== ===========
Average Number of Common Shares Outstanding............. 39,118 39,118
=========== ===========
Net Earnings per Share of Common Stock.................. $ 1.23 $ 0.63
=========== ===========
Earnings from continuing operations..................... 0.28 0.63
Cumulative effect of a change in accounting principle... 0.95 -
----------- -----------
Net earnings per share of common stock (basic).......... $ 1.23 $ 0.63
=========== ===========
Diluted:
Net Earnings Applicable to Common Stock
Used in basic calculation............................... $ 48,170 $ 24,803
=========== ===========
Average Number of Common Shares Outstanding............. 39,118 39,118
Dilutive effect of common stock equivalents (a)......... 247 531
----------- -----------
Average common and common equivalent shares
Outstanding............................................. 39,365 39,649
=========== ===========
Net Earnings per Share of Common Stock (Diluted)........ $ 1.22 $ 0.63
=========== ===========
(a) Excludes the effect of average anti-dilutive common stock
equivalents related to out-of-the-money options of 1,879,087 and
14,000 for the three months ended March 31, 2003 and 2002,
respectively.
(5) Commitments and Contingencies
Natural Gas Explosion
On April 25, 2001, a natural gas explosion occurred in Santa Fe, New
Mexico. The apparent cause of the explosion was a leak from a PNM gas line near
the location. The explosion destroyed a small building and injured two persons
who were working in the building. PNM's investigation indicates that the leak
27
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
was an isolated incident likely caused by a combination of corrosion and
increased pressure. PNM also cooperated with an investigation of the incident by
the PRC's Pipeline Safety Bureau (the "Bureau"), which issued its report on
March 18, 2002. The Bureau's report gave PNM notice of probable violations of
the New Mexico Pipeline Safety Act and related regulations. PNM and the Bureau
staff entered into a compliance agreement addressing the probable violations and
filed it with the PRC for approval on March 4, 2003. PNM agreed to undertake a
list of twenty-four corrective actions, including internal policy changes,
retraining employees and enhancing gas line monitoring. PNM has also agreed to
voluntarily accelerate spending on pipeline replacement by more than $10.0
million and to commit an additional $1.8 million to development and
implementation of systems to improve gas line management. The compliance
agreement was approved by the PRC on March 25, 2003. No civil penalty was
imposed. Two lawsuits against PNM by the injured persons along with several
claims for property and business interruption damages have been resolved.
Global Electric Agreement
On October 10, 2002, PNM announced that it had agreed with the PRC staff,
the New Mexico Attorney General ("AG"), and other consumer groups on a Global
Electric Agreement that provided for joint support to repeal a majority of the
New Mexico Utility Industry Restructuring Act of 1999 ("Restructuring Act"), as
amended, a five-year rate path, procedures for the Company's participation in
wholesale plant activities and other regulatory issues. The Global Electric
Agreement was approved by the PRC on January 28, 2003. Legislation repealing the
Restructuring Act, as amended, and continuing the authorization for utilities to
participate in wholesale plant activities for a limited time according to the
Global Electric Agreement was passed by the New Mexico Legislature and signed
into law by the Governor on April 8, 2003. In the Global Electric Agreement, PNM
agreed to forego recovery of the costs incurred in preparing to transition to a
competitive retail market in New Mexico. This resulted in a charge of $16.7
million, pre-tax, in the first quarter of 2003. As a result of the repeal of the
Restructuring Act, PNM has re-applied the accounting requirements of SFAS 71 to
its regulated generation activities effective January 28, 2003, which did not
have a material effect on the Company's financial condition or results of
operations.
Other
There are various claims and lawsuits pending against the Company. The
Company is also subject to federal, state and local environmental laws and
regulations, and is currently participating in the investigation and remediation
of numerous sites. In addition, the Company periodically enters into financial
commitments in connection with its business operations. It is not possible at
this time for the Company to determine fully the effect of all litigation on its
consolidated financial statements. However, the Company has recorded a liability
where the litigation effects can be estimated and where an outcome is considered
probable. The Company does not expect that any known lawsuits, environmental
costs and commitments will have a material adverse effect on its financial
condition or results of operations.
28
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company is involved in various legal proceedings in the normal course
of business. The associated legal costs for these legal matters are accrued when
incurred. It is also the Company's policy to accrue for legal costs expected to
be incurred in connection with SFAS 5 legal matters when it is probable that a
SFAS 5 liability has been incurred and the amount of expected legal costs to be
incurred is reasonably estimable. These estimates include costs for external
counsel professional fees.
(6) Company Realignment
On August 22, 2002, the Company was realigned due to the changes in the
electric industry and particularly, the negative impact on the Company's
earnings and growth prospects from wholesale market uncertainty. The changes
included consolidation of similar functions. A total of 85 salaried and hourly
employees were notified of their termination as part of the realignment. In
accordance with Emerging Issues Task Force 94-3 ("EITF 94-3"), "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity", the Company incurred a liability of $8.8 million for severance and
other related costs associated with the involuntary termination of employees,
which was charged to operations in the quarter ended September 30, 2002. The
Company had paid $5.5 million as of March 31, 2003 for such costs.
(7) Other Income and Deductions
The following table details the components of other income and deductions
for PNM Resources, Inc. and Subsidiaries:
Three Months Ended
March 31,
---------------------------
2003 2002
------------- ------------
(In thousands)
Other income:
Interest and dividend income............... $ 10,700 $ 11,832
Miscellaneous non-operating income......... 506 1,895
------------- ------------
$ 11,206 $ 13,727
============= ============
Other deductions:
Transition costs write-off................. 16,720 -
Miscellaneous non-operating deductions..... 1,192 1,497
------------- ------------
$ 17,912 $1,497
============= ============
(Intentionally left blank)
29
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table details the components of other income and deductions
for PNM:
Three Months Ended
March 31,
---------------------------
2003 2002
------------- ------------
(In thousands)
Other income:
Interest and dividend income............... $ 10,117 $ 10,011
Miscellaneous non-operating income......... 376 354
------------- ------------
$ 10,493 $ 10,365
============= ============
Other deductions:
Transition costs write-off................. 16,720 -
Miscellaneous non-operating deductions..... 1,761 2,126
------------- ------------
$ 18,481 $2,126
============= ============
(8) New and Proposed Accounting Standards
Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities", an interpretation of Accounting
Research Bulletin (ARB) No. 51, "Consolidated Financial Statements" ("FIN 46").
In January 2003, the Financial Accounting Standards Board ("FASB") issued FIN 46
to address the consolidation of variable interest entities that have one or both
of the following characteristics: (1) the equity investment at risk is not
sufficient to permit the entity to finance its activities without additional
subordinated financial support from other parties, which is provided through
other interests that will absorb some or all of the expected losses of the
entity and (2) the equity investors lack one or more of the following essential
characteristics of a controlling financial interest: (a) the direct or indirect
ability to make decisions about the entity's activities through voting rights or
similar rights, (b) the obligation to absorb the expected losses of the entity
if they occur, which makes it possible for the entity to finance its activities,
or (c) the right to receive the expected residual returns of the entity if they
occur, which is the compensation for the risk of absorbing the expected losses.
FASB believes that if a business enterprise has a controlling financial interest
in a variable interest entity, the assets, liabilities, and results of the
activities of the variable interest entity should be included in consolidated
financial statements with those of the business enterprise. FIN 46 requires
existing unconsolidated variable interest entities to be consolidated by their
primary beneficiaries if the entities do not effectively disperse risks among
parties involved. There are also additional disclosure requirements for an
enterprise that holds significant variable interests in a variable interest
entity but is not the primary beneficiary. FIN 46 applies immediately to
variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date and
may be applied prospectively with a cumulative-effect adjustment as of the date
on which it is first applied or by restating previously issued financial
statements for one or more years with a cumulative-effect adjustment as of the
beginning of the first year restated. The adoption of FIN 46 as of February 1,
2003, did not have a material impact on the Company's financial condition or
results of operations.
30
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
EITF 02-3 "Issues Related to Accounting for Contracts Involved in Energy
Trading and Risk Management Activities", EITF 98-10 "Accounting for Contracts
Involved in Energy Trading and Risk Management Activities" and Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). On October 25, 2002, the EITF reached a
final consensus on EITF 02-3 that rescinds EITF 98-10 and requires that all
energy contracts held for trading purposes be presented on a net margin basis in
the statement of earnings. The rescission of EITF 98-10 requires that energy
contracts which do not meet the definition of a derivative under SFAS 133 no
longer be marked to market and recognized in current earnings. As a result, all
contracts which were marked to market under EITF 98-10 and must now be accounted
for under the accrual method should be written back to cost with any difference
included as a cumulative effect of a change in accounting principle in the
period of adoption. This transition provision was effective January 1, 2003. The
rescission of EITF 98-10 did not have a material impact on the Company's
financial condition or results of operations as all contracts previously marked
to market under the definition provided in EITF 98-10 also met the definition of
a derivative under SFAS 133 and are properly recorded at fair value with gains
and losses recorded in earnings. The Company reviewed its energy contract
portfolio to determine whether its contracts meet the definition of trading
activities under EITF 02-3. As a result, the Company has reclassified those
contracts previously accounted for under EITF 98-10 to a net margin basis for
the three months ended March 31, 2002. The Company will not report revenues and
cost of energy sold on a net margin basis on a prospective basis as a result of
the application of EITF 02-3 as none of the Company's marketing activities meet
the definitions of trading activities as prescribed by EITF 02-3.
The following table details wholesale electric revenues as adjusted under
EITF 02-3:
Three Months Ended
March 31, 2002
--------------------
(In thousands)
Wholesale revenues.............................. $ 17,743
Wholesale purchases (EITF 02-3 adjustment)...... (16,488)
---------------
Energy trading margin........................... $ 1,255
===============
Statement of Financial Account Standards No. 149 "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). On April 30,
2003, the FASB issued SFAS 149. SFAS 149 amends SFAS 133 for derivative
instruments, including certain derivative investments embedded in other
contracts and for hedging activities. SFAS 149 also amends certain existing
pronouncements. It will require contracts with comparable characteristics to be
accounted for similarly. In particular, SFAS 149 clarifies when a contract with
an initial net investment meets the characteristics of a derivative and
clarifies when a derivative that contains a financing component will require
special reporting in the statement of cash flows. SFAS 149 is effective for the
Company for contracts entered into or modified after June 30, 2003. The Company
is currently evaluating the impact of adopting the requirements of SFAS 149.
31
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(9) Subsequent Events
Asset Securitization
On April 9, 2003, PNM entered into a transaction providing for the
securitization of PNM's retail electric service accounts receivable and retail
gas service accounts receivable ("AR Securitization"). The total capacity under
the AR Securitization is $90 million. Under the AR Securitization, PNM will
periodically sell its accounts receivable to a bankruptcy remote subsidiary, PNM
Receivables Corp, which in turn sells or pledges an undivided interest in the
receivables to an unaffiliated conduit commercial paper issuer. This transaction
was previously approved by the PRC on December 17, 2002.
Eastern Interconnection Project ("EIP") Purchase
On April 1, 2003, PNM exercised its early buyout option related to its
60% ownership interest in the EIP transmission line and related facilities. In
conjunction with the early buyout option, PNM retired $26.2 million of 10.25%
debt. Additionally, PNM acquired EIP Refunding Corporation, which caused the
remaining 10.25% publicly traded EIP Secured Facility Bonds to be retired and
effectively defeased that debt. The Company will continue to reflect $4.6
million of lease obligations relating to the 40% interest the Company does not
own as off balance sheet debt.
Refinance of Pollution Control Bonds
On May 13, 2003, the Company priced $182 million of tax-exempt pollution
control bonds. The bonds were priced at a one-year interest rate of 2.75%. The
bond sale is scheduled to close on May 23, 2003. The bonds will need to be
remarketed at the end of the one-year interest rate period. The proceeds will be
used to refund the $46 million of pollution control bonds, which became callable
on December 15, 2002. Additionally, the remaining $136 million will be placed in
an escrow account to be used to refund the same amount of pollution control
bonds, which will become callable on August 15, 2003. Both of these issuances
were previously hedged.
Pension and Other Post-Retirement Benefits
On May 13, 2003, the board of directors approved the use of Holding
Company stock in the funding of the Company's defined benefit pension plan as
well as its retiree medical trust. Corporate plan sponsors may make
contributions of common stock to their defined benefit plans of up to 10% of the
value of the portfolio without Department of Labor approval; provided that the
contribution does not otherwise constitute a prohibited transaction under ERISA.
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Holding Company and its subsidiaries and PNM is
presented on a combined basis. The Holding Company incurs substantially all of
the corporate activities of PNM. These activities are billed to PNM on a cost
basis to the extent they are for the corporate management of PNM. In January
2002, Avistar and certain inactive subsidiaries were transferred by way of a
dividend to the Holding Company pursuant to an order from the PRC. The business
of PNM constitutes substantially all of the business of the Company. Therefore,
the financial results and results of operations of PNM are virtually identical
to the consolidated results of the Holding Company and all its subsidiaries. For
discussion purposes, this report will use the term "Company" when discussing
matters of common applicability to the Holding Company and PNM. Readers of
Management's Discussion and Analysis of Financial Condition and Results of
Operations should assume that the information presented applies to consolidated
results of operations and financial position of both the Holding Company and its
subsidiaries and PNM, except where the context or references clearly indicate
otherwise. In the case of contractual obligations of PNM, these obligations are
consolidated with the Holding Company and its subsidiaries under GAAP. Broader
operational discussions refer to the Company.
The following is management's assessment of the Company's financial
condition and the significant factors affecting the results of operations. This
discussion should be read in conjunction with the Company's consolidated
financial statements and related notes. Trends and contingencies of a material
nature are discussed to the extent known and considered relevant.
OVERVIEW
The Holding Company is an investor-owned holding company of energy and
energy related companies. Its principal subsidiary, PNM, is an integrated public
utility primarily engaged in the generation, transmission, distribution and sale
and marketing of electricity; transmission, distribution and sale of natural gas
within the State of New Mexico; and the sale and marketing of electricity in the
Western United States.
COMPETITIVE STRATEGY
The Company is positioned as a "merchant utility," primarily operating as
a regulated energy service provider. The Company is also engaged in the sale and
marketing of electricity in the competitive energy market place. As a utility,
PNM has an obligation to serve its customers under the jurisdiction of the PRC.
As a wholesale electricity provider, PNM markets excess production from the
utility, as well as unregulated generation, into a competitive marketplace. Part
of its electric wholesale power operation, it may purchase wholesale electricity
in the open market for future resale or to provide energy to retail customers in
New Mexico when the Company's generation assets cannot satisfy demand. The
wholesale operations utilize an asset-backed strategy, whereby the Company's
aggregate net open position for the sale of electricity is covered by the
Company's forecasted excess generation capabilities.
33
As it currently operates, the Company's principal business segments are
Utility Operations and Wholesale Operations ("Wholesale"). Utility Operations
include Electric Services ("Electric"), Transmission Services ("Transmission")
and Gas Services ("Gas"). Electric consists of the distribution and generation
of electricity for retail customers. Wholesale consists of three product lines
that include long-term contracts, forward sales and short-term sales.
The Utility Operations strategy is directed at supplying reasonably
priced and reliable energy to retail customers through customer-driven
operational excellence, high quality customer service, cost efficient processes,
and improved overall organizational performance.
The Wholesale Operations strategy calls for increased asset-backed energy
sales supported by long-term contracts and the wholesale market. The
asset-backed sales are actively monitored by management by the use of stringent
risk management policies. The Company's future growth plans call for
approximately 75% of its new generation portfolio to be committed through
long-term contracts, including sales to retail customers. Currently, unregulated
generation sales capacity is committed to long-term contract sales in excess of
the 75% goal. Any additions will be made with the same commitment to the
long-term sales market. Growth will be dependent on market development, and upon
the Company's ability to generate funds for the Company's future expansion.
Although the current economic environment has led the Company to scale back its
expansion plans, the Company will continue to operate in the wholesale market
and seek rationally priced asset additions. Expansion of the Company's
generating portfolio will depend upon acquiring favorably priced assets at
strategic locations and securing long-term commitments for the purchase of power
from the acquired plants.
(Intentionally left blank)
34
RESULTS OF OPERATIONS
Three Months Ended March 31, 2003
Compared to Three Months Ended March 31, 2002
Consolidated
The Company's net earnings available to common shareholders for the three
months ended March 31, 2003 were $48.2 million, a 94.4% increase in net earnings
compared to $24.8 million in 2002. This increase primarily reflects the
cumulative effect of a change in accounting principle for the adoption of SFAS
143 of $37.4 million, net of tax. This increase was partially offset by the
write-off of transition costs of $16.7 million and planned and unplanned outages
at San Juan Generating Station ("SJGS"). The restricted output from SJGS
adversely impacted both the opportunity to generate wholesale revenues in the
quarter and also increased purchased power costs.
The following discussion is based on the financial information presented
in the Consolidated Financial Statements - Segment Information Note 2, in the
Notes to the Consolidated Financial Statements. Corporate allocations, income
taxes and non-operating items are discussed only on a consolidated basis.
Utility Operations
Electric
The table below sets forth the operating results for the Electric
business segment.
Three Months Ended
March 31,
-------------------------------
2003 2002 Variance
-------------- -------------- ------------
(In thousands)
Operating revenues......................... $133,600 $135,419 $(1,819)
Less: Cost of energy....................... 41,386 40,351 1,035
Energy transfer..................... (10,112) (8,626) (1,486)
-------------- --------------- -------------
Gross margin............................... 102,326 103,694 (1,368)
-------------- --------------- -------------
Energy production costs.................... 27,712 28,216 (504)
Transmission and distribution O&M.......... 9,268 8,593 675
Customer related expense................... 2,279 3,910 (1,631)
Administrative and general................. 781 532 249
-------------- --------------- -------------
Total non-fuel O&M....................... 40,040 41,251 (1,211)
-------------- --------------- -------------
Corporate allocation....................... 14,128 13,086 1,042
Depreciation and amortization.............. 18,057 17,008 1,049
Taxes other than income taxes.............. 5,849 5,296 553
Income taxes............................... 6,242 7,437 (1,195)
-------------- --------------- -------------
Total non-fuel operating expenses........ 84,316 84,078 238
-------------- --------------- -------------
Operating income........................... $18,010 $19,616 $(1,606)
-------------- --------------- -------------
35
The following table shows electric revenues by customer class and average
customers:
Electric Revenues
Three Months Ended
March 31,
---------------------------
2003 2002 Variance
------------ ------------- -------------
(In thousands)
Residential.................. $50,963 $50,722 $ 241
Commercial................... 55,106 55,005 101
Industrial................... 18,751 19,628 (877)
Transmission................. 4,557 6,075 (1,518)
Other........................ 4,223 3,989 234
------------ ------------- -------------
$133,600 $135,419 $ (1,819)
============ ============= =============
Average customers............ 392,529 381,661 10,868
============ ============= =============
The following table shows electric sales by customer class:
Electric Sales
(Megawatt hours)
Three Months Ended
March 31,
------------------------------
2003 2002 Variance
------------- -------------- -------------
(In thousands)
Residential................ 592,135 588,996 3,139
Commercial................. 720,862 711,259 9,603
Industrial................. 371,635 392,346 (20,711)
Other...................... 42,886 46,874 (3,988)
------------- -------------- -------------
1,727,518 1,739,475 (11,957)
============= ============== =============
Operating revenues decreased $1.8 million or 1.3% for the period.
Retail electricity delivery declined to 1.73 million MWh in 2003 compared to
1.74 million MWh delivered in the prior year, resulting in decreased revenues.
This volume decrease was the result of the reclassification of a significant
customer from retail to wholesale rates in the first quarter of 2003, partially
offset by customer growth. Despite year-over-year customer growth of 2.8%,
retail usage remained relatively flat excluding the transfer of a retail
customer to wholesale operations. Without the customer reclassification, volume
increased 0.7%. In addition, transmission revenues decreased $1.5 million
primarily due to lower demand for wheeling to California from PVNGS as a result
of lower transmission demand in the California market.
The gross margin, or operating revenues minus cost of energy sold,
decreased $1.4 million or 1.3%. This decrease is due mainly to the decrease in
transmission revenues, partially offset by customer growth in the Company's
retail electric service territory.
Total non-fuel O&M expenses decreased $1.2 million or 2.9%. Energy
production costs decreased $0.5 million primarily due to costs of $1.9 million
related to various planned and unplanned outages at SJGS. However, this increase
36
was mostly offset by decreased costs of $1.7 million at Four Corners related to
an outage in 2002 which did not recur in 2003. Customer related expense
decreased $1.6 million due to lower bad debt levels as a result of collection
improvements. Depreciation and amortization increased $1.0 million due to a
higher depreciable plant base.
Gas
The table below sets forth the operating results for the Gas business
segment.
Three Months Ended
March 31,
--------------------------------
2003 2002 Variance
--------------- -------------- ---------------
(In thousands)
Operating revenues....................... $146,253 $109,201 $37,052
Cost of energy........................... 104,878 64,749 40,129
--------------- -------------- ---------------
Gross margin............................. 41,375 44,452 (3,077)
--------------- -------------- ---------------
Energy production costs.................. 510 531 (21)
Transmission O&M......................... 1,640 1,867 (227)
Distribution O&M......................... 6,340 6,064 276
Customer related expense................. 3,788 3,989 (201)
Administrative and general............... 95 574 (479)
--------------- -------------- ---------------
Total non-fuel O&M..................... 12,373 13,025 (652)
--------------- -------------- ---------------
Corporate allocation..................... 8,020 7,553 467
Depreciation and amortization............ 5,442 5,062 380
Taxes other than income taxes............ 2,041 2,043 (2)
Income taxes............................. 4,103 5,326 (1,223)
--------------- -------------- ---------------
Total non-fuel operating expenses...... 31,979 33,009 (1,030)
--------------- -------------- ---------------
Operating income......................... $ 9,396 $11,443 $ (2,047)
--------------- -------------- ---------------
The following table shows gas revenues by customer and average customers:
Gas Revenues
Three Months Ended
March 31,
--------------------------------
2003 2002 Variance
-------------- -------------- --------------
(In thousands)
Residential............... $97,974 $72,112 $25,862
Commercial................ 30,421 22,399 8,022
Industrial................ 1,031 649 382
Transportation............ 3,745 3,611 134
Other..................... 13,082 10,430 2,652
-------------- -------------- --------------
$146,253 $109,201 $37,052
============== ============== ==============
Average customers......... 452,162 443,927 8,235
============== ============== ==============
37
The following table shows gas throughput by customer class:
Gas Throughput
Three Months Ended
March 31,
--------------------------------
2003 2002 Variance
-------------- --------------- --------------
(Thousands of decatherms)
Residential............. 12,206 13,516 (1,310)
Commercial.............. 4,334 4,970 (636)
Industrial.............. 186 172 14
Transportation.......... 8,635 7,397 1,238
Other................... 1,943 1,990 (47)
-------------- --------------- --------------
27,304 28,045 (741)
============== =============== ==============
Operating revenues increased $37.1 million or 34.0% for the period to
$146.3 million, primarily because of higher natural gas prices in 2003 as
compared to 2002, partially offset by a decrease in gas sales volumes of 2.6%,
largely resulting from warmer weather. PNM purchases natural gas in the open
market and resells it at cost to its distribution customers. As a result,
increases or decreases in gas revenues driven by gas costs do not impact the
Company's consolidated gross margin or earnings.
The gross margin, or operating revenues minus cost of energy sold,
decreased $3.1 million or 6.9%. This decrease is due mainly to a weather related
decline in gas volumes and the expiration in January 2003 of a rate rider for
the recovery of certain costs of $1.0 million. January 2003 was the warmest
January in recorded history in New Mexico. The Company currently believes that
gas assets are not earning an adequate level of return. As a result, the Company
filed a request for increased rates in January 2003 requesting an increase in
rates of $37.5 million annually. The Company's last gas rate case filing was in
October 1997.
Total non-fuel O&M expenses decreased $0.7 million or 5.0%.
Administrative and general costs decreased $0.5 million or 83.4% primarily due
to cost control initiatives.
(Intentionally left blank)
38
Wholesale
The table below sets forth the operating results for the Wholesale
business segment.
Three Months Ended
March 31,
-----------------------------------
2003 2002 Variance
---------------- --------------- --------------
(In thousands)
Operating revenues......................... $ 107,778 $ 56,542 $51,236
Cost of energy............................. 89,781 46,632 43,149
---------------- ---------------- --------------
Gross margin............................... 17,997 9,910 8,087
---------------- ---------------- --------------
Energy production costs.................... 6,872 6,224 648
Administrative and general................. 2,050 1,227 823
---------------- ---------------- --------------
Total non-fuel O&M....................... 8,922 7,451 1,471
---------------- ---------------- --------------
Corporate allocation....................... 929 1,156 (227)
Depreciation and amortization.............. 3,491 1,856 1,635
Taxes other than income taxes.............. 811 698 113
Income taxes............................... 1,049 (905) 1,954
---------------- ---------------- --------------
Total non-fuel operating expenses........ 15,202 10,256 4,946
---------------- ---------------- --------------
Operating income (loss).................... $ 2,795 $ (346) $ 3,141
---------------- ---------------- --------------
The following table shows revenues by customer class:
Wholesale Revenues
Three Months Ended
March 31,
--------------------------------
2003 2002 Variance
-------------- -------------- --------------
(In thousands)
Long-term contracts.......... $26,179 $17,015 $ 9,164
Forward sales................ 22,938 1,255 21,683
Short-term sales............. 58,661 38,272 20,389
-------------- -------------- --------------
$107,778 $56,542 $51,236
============== ============== ==============
The following table shows sales by customer class:
Wholesale Sales
Three Months Ended
March 31,
--------------------------------
2003 2002 Variance
-------------- --------------- --------------
(Megawatt hours)
Long-term contracts......... 501,445 281,153 220,292
Forward sales............... 562,200 - 562,200
Short-term sales............ 1,456,738 1,838,146 (381,408)
-------------- --------------- --------------
2,520,383 2,119,299 401,084
============== =============== ==============
39
Operating revenues increased $51.2 million or 90.6% for the period to
$107.8 million. This increase in wholesale electric sales primarily reflects new
long-term contract sales and improved wholesale market conditions. The average
price realized by the Company was $42 per MWh for the three months ended March
31, 2003 compared to $24 per MWh for the same period in 2002. The Company
delivered wholesale (bulk) power of 2.5 million MWh of electricity for the three
months ended March 31, 2003, compared to 2.1 million MWh for the same period in
2002. In addition, effective January 1, 2003, the Company adopted EITF 02-3
which resulted in the reclassification of contracts that were previously
accounted for under EITF 98-10 to a net margin basis for the three months ended
March 31, 2002. Therefore, in 2002, $16.5 million of purchased power expense was
netted against revenues for a net margin of $1.3 million in 2002. These sales
and purchases were accounted for in the forward sales market.
The gross margin, or operating revenues minus cost of energy sold,
increased $8.1 million or 81.6%. Higher margins were created primarily by new
long-term sales contracts, higher market prices and improved market liquidity.
The addition of long-term contracts added $5.0 million or 61.7% of the total
gross margin increase for the quarter. This increase was partially offset by
planned and unplanned outages at SJGS which reduced availability of power for
wholesale sales. In addition, the Company had to buy power in the market at
higher prices to cover its contractual obligations, which resulted in increased
power costs. The Company also had an unfavorable change in the unrealized
mark-to-market position of the forward sales portfolio of $2.5 million
period-over-period ($1.3 million loss in 2003 versus $1.2 million gain in 2002).
Total non-fuel O&M expenses increased $1.5 million or 19.7%. Energy
production costs increased $0.6 million or 10.4% primarily due to costs of $0.3
million related to various planned and unplanned outages at SJGS. In addition,
Afton and Lordsburg, which became operational in late 2002, incurred operating
costs of $0.3 million in 2003. Administrative and general increased $0.8 million
primarily due to combustion turbine storage costs of $0.5 million. Depreciation
and amortization increased $1.6 million primarily due to the addition of the new
Lordsburg and Afton gas fired facilities.
Corporate and Other
Corporate administrative and general, which represent costs that are
driven primarily by corporate-level activities, is allocated to the business
segments and is presented in the corporate allocation line item in the segment
statements. These costs increased $1.8 million or 8.5% for the period to $23.0
million. The increase was due to increased pension and benefits expense of $1.8
million and healthcare costs of $0.8 million. These increases were partially
offset by lower compensation costs of $1.1 million.
Taxes other than income decreased $1.4 million to income of $0.9 million
due to the favorable assessment of outstanding tax issues.
Consolidated Non-Operating
Other Income and Deductions
Other income decreased by $2.5 million or 18.4% reflecting lower
year-over-year returns on investments reflecting a decrease in the short-term
investment balance.
40
Other deductions increased $16.4 million primarily due to a charge of
$16.7 million in 2003 for the write-off of transition costs previously
capitalized in anticipation of deregulation in New Mexico.
Interest Expense
Interest expense increased $3.1 million or 20.5% primarily due to
increased short-term borrowings and by decreased capitalized interest of $1.6
million.
Income Taxes
The Company's consolidated income tax expense before the cumulative
effect of a change in accounting principle was $6.5 million for the three months
ended March 31, 2003, compared to $14.2 million for the three months ended March
31, 2002. The decrease was due to the impact of lower pre-tax earnings. The
Company's effective income tax rates for the three months ended March 31, 2003
and 2002 were 37.26% and 36.28%, respectively. The increase in the effective
rate period over period was due to the reduction in permanent tax benefits.
Cumulative Effect of a Change in Accounting Principle
Effective January 1, 2003, the Company adopted SFAS 143. The effect of
the initial application of the new standard is reported as a cumulative effect
of a change in accounting principle. As a result, the Company recorded
additional earnings, net of taxes, of approximately $37.4 million, or $0.95 per
diluted common share, representing amounts expensed in prior years in excess of
legal obligations related to fossil-fuel and nuclear generation plants.
FUTURE EXPECTATIONS
Based on first quarter results and its financial and operating forecasts
for the remainder of the year, the Company reaffirmed its existing 2003 earnings
guidance in its earnings release on April 29, 2003. The Company expects 2003
ongoing earnings will be in the range of $1.80 and $2.05 per diluted share,
excluding the impact of the adoption of SFAS 143 and the write-off of transition
costs.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2003, the Company had cash and short-term investments of
$54.2 million compared to $83.3 million in cash and short-term investments at
December 31, 2002.
Cash provided by operating activities for the three months ended March
31, 2003 was $6.3 million compared to $13.0 million for the three months ended
March 31, 2002. This decrease was primarily due to an increase in accounts
receivable resulting from higher wholesale electric prices and volume and higher
gas prices in the current quarter. The Company did not make its first quarter
2001 estimated federal income tax payment of $32.0 million until January 2002
because of an extension granted by the IRS to taxpayers in several counties in
New Mexico as a result of wildfires in 2000. This non-recurring payment in 2002
partially offset the decrease in cash from operating activities period over
period.
41
Cash provided by investing activities was $32.8 million in 2003 compared
to cash used for investing activities of $62.5 million in 2002. The cash
provided by investing activities in 2003 included the redemption of short-term
investments of $79.4 million in 2003 at the parent level only. Cash used in 2002
for investing activities includes construction expenditures for new generating
plants of $29.9 million. Payments for combustion turbines not yet included in
plant were $11.1 million in 2003 compared to $7.8 million in 2002. In addition,
cash used for investing activities in 2003 included the re-purchase of the
Company's EIP bonds in the open market for $7.4 million.
Cash generated by financing activities was $10.5 million in 2003 compared
to $47.8 million in 2002. Financing activities consisted of primarily short-term
borrowings of $20.0 million in 2003 compared to $58.8 million in 2002 for
liquidity reasons, partially offset by an 8% increase in cash payments for
common stock dividends in 2003.
Pension and Other Post-Retirement Benefits
On May 13, 2003, the board of directors approved the use of Holding
Company stock in the funding of the Company's defined benefit pension plan as
well as its retiree medical trust. Corporate plan sponsors may make
contributions of common stock to their defined benefit plans of up to 10% of the
value of the portfolio without Department of Labor approval; provided that the
contribution does not otherwise constitute a prohibited transaction under ERISA.
Capital Requirements
Total capital requirements include construction expenditures as well as
other major capital requirements and cash dividend requirements for both common
and preferred stock. The main focus of the Company's current construction
program is upgrading generation systems, upgrading and expanding the electric
and gas transmission and distribution systems, and purchasing nuclear fuel. To
preserve a strong financial position, the Company announced in 2002 its plans to
eliminate capital expenditures for previously planned generation expansion until
market conditions warrant further investment. Projections for total capital
requirements for 2003 are $176 million and projections for construction
expenditures for 2003 are $156 million. For 2003-2007 projections, total capital
requirements are $800 million and construction expenditures are $708 million.
These estimates are under continuing review and subject to on-going adjustment.
In the three months ended March 31, 2003, the Company utilized cash
generated from operations and cash on hand, as well as its liquidity
arrangements, to cover its construction commitments. The Company anticipates
that internal cash generation and current debt capacity will be sufficient to
meet all its capital requirements for the years 2003 through 2007. To cover the
difference in the amounts and timing of cash generation and cash requirements,
the Company intends to use short-term borrowings under its current and future
liquidity arrangements.
Liquidity
As of May 1, 2003, PNM had $305 million of liquidity arrangements. The
liquidity arrangements consist of $195 million from an unsecured revolving
credit facility ("Credit Facility"), a $90 million from an accounts receivable
42
securitization program ("AR Securitization") and $20 million in local lines of
credit. PNM entered into a new revolving credit facility on December 19, 2002,
which increased borrowing capacity from $150 million to $195 million. This
facility will mature December 18, 2003. PNM entered into its AR Securitization
on April 9, 2003 which increased liquidity capacity by up to $90 million (see
below). This facility will mature April 9, 2006. There were $120 million in
borrowings against the Credit Facility and the Company was using $50 million of
the AR Securitization capacity as of May 1, 2003. In addition, the Holding
Company has $15 million in local lines of credit.
On April 9, 2003, the Company entered into a transaction providing for
the securitization of PNM's retail electric service accounts receivable and
retail gas services accounts receivable. The total capacity under the AR
Securitization is $90 million. Under the AR Securitization, PNM will
periodically sell its accounts receivable to a bankruptcy remote subsidiary, PNM
Receivables Corp, which in turn sells or pledges an undivided interest in the
receivables to an unaffiliated conduit commercial paper issuer. This transaction
was previously approved by the PRC on December 17, 2002.
On April 1, 2003, PNM exercised its early buyout option related to its
60% ownership interest in the EIP transmission line and related facilities. In
conjunction with the early buyout option, PNM retired $26.2 of 10.25% debt.
Additionally, PNM acquired EIP Refunding Corporation, which caused the remaining
10.25% publicly traded EIP Secured Facility Bonds to be retired and effectively
defeased that debt. The Company will continue to reflect $4.6 million of lease
obligations relating to the 40% interest the Company does not own as off balance
sheet debt.
The Company's ability, if required, to access the capital markets at a
reasonable cost and to provide for other capital needs is largely dependent upon
its ability to earn a fair return on equity, results of operations, credit
ratings, regulatory approvals and financial and wholesale market conditions.
Financing flexibility is enhanced by providing a high percentage of total
capital requirements from internal sources and having the ability, if necessary,
to issue long-term securities, and to obtain short-term credit.
PNM's credit outlook is considered stable by Moody's Investor Services,
Inc. ("Moody's") and Standard and Poor's Ratings Services ("S&P") and positive
by Fitch, Inc. ("Fitch"). The Company is committed to maintaining or improving
its investment grade ratings. S&P currently rates PNM's senior unsecured notes
("SUNs") "BBB-" and its preferred stock "BB". Moody's rates PNM's SUNs and
senior unsecured pollution control revenue bonds "Baa3" and preferred stock
"Ba1". Fitch rates PNM's SUNs and senior unsecured pollution control revenue
bonds "BBB-" and PNM's preferred stock "BB-." Investors are cautioned that a
security rating is not a recommendation to buy, sell or hold securities, that it
is subject to revision or withdrawal at any time by the assigning rating
organization, and that each rating should be evaluated independently of any
other rating.
Planned Financing Activities
As of March 31, 2003, PNM had $268.4 million of long-term debt that
matures in August 2005. All other long-term debt of PNM matures in 2016 or
later. The Company could enter into other long-term financings for the purpose
of strengthening its balance sheet, funding growth and reducing its cost of
43
capital. The Company continues to evaluate its investment and debt retirement
options to optimize its financing strategy and earnings potential. No additional
first mortgage bonds may be issued under PNM's mortgage. The amount of SUNs that
may be issued is not limited by the SUNs indenture. However, debt-to-capital
requirements in certain of PNM's financial instruments and regulatory agreements
would ultimately limit the amount of additional debt PNM would issue.
PNM currently has $46 million of tax-exempt bonds outstanding that were
callable at a premium beginning December 15, 2002, and an additional $136
million that become callable at a premium in August 15, 2003. PNM intends to
refinance these bonds, assuming the interest rate of the refinancing does not
exceed the current interest rate of the bonds, and has hedged the entire planned
refinancing. The Company received regulatory approval to refund the tax-exempt
bonds on October 29, 2002. This approval is effective for one year. In order to
take advantage of current low interest rates, PNM entered into five forward
starting interest rate swaps in the fourth quarter of 2001 and the first quarter
of 2002. PNM designated these swaps as cash flow hedges. The hedged risks
associated with these instruments are the changes in cash flows related to
general moves in interest rates expected for the refinancing. The swaps
effectively cap the interest rate on the refinancing to 4.95% plus an adjustment
for PNM's and the industry's credit rating. PNM's assessment of hedge
effectiveness is based on changes in the hedge interest rates. The derivative
accounting rules, as amended, provide that the effective portion of the gain or
loss on a derivative instrument designated and qualifying as a cash flow hedging
instrument be reported as a component of other comprehensive income and be
reclassified into earnings in the same period or periods during which the hedged
forecasted transactions settle. Any hedge ineffectiveness is required to be
presented in current earnings. There was no material hedge ineffectiveness in
the three months ended March 31, 2003. At March 31, 2003, the fair market value
of these derivative financial instruments was approximately $21.0 million
unfavorable to the Company.
A forward starting swap does not require any upfront premium and captures
changes in the corporate credit component of an investment grade company's
interest rate as well as the underlying benchmark. The five forward starting
interest rate swaps have a termination date of May 15, 2003 for a combined
notional amount of $182.0 million. There were no fees on the transaction, as
they are imbedded in the rates, and the transaction will be settled in cash on
the mandatory strike date corresponding to the refinancing date of the
underlying debt. The settlement will be capitalized as a cost of issuance and
amortized over the life of the debt as a yield adjustment provided that the
forecasted transactions (interest payments) occur as anticipated. The Company
believes that it will recover any hedge cost which could not be capitalized
under accounting rules in its next rate proceeding.
On May 13, 2003, the Company priced $182 million of tax exempt pollution
control bonds. The bonds were priced at a one-year interest rate of 2.75%. The
bond sale is scheduled to close on May 23, 2003. The bonds will need to be
remarketed at the end of the one-year interest rate period. The proceeds will be
used to refund the $46 million of pollution control bonds, which became callable
on December 15, 2002. Additionally, the remaining $136 million will be placed in
an escrow account to be used to refund the same amount of pollution control
bonds, which will become callable on August 15, 2003. Both of these issuances
were previously hedged.
44
Capital Structure
The Company's capitalization, including current maturities of long-term
debt, at March 31, 2003 and December 31, 2002 is shown below:
March 31, December 31,
2003 2002
---------------- -----------------
Common Equity................... 50.2% 49.2%
Preferred Stock................. 0.6 0.7
Long-term Debt.................. 49.2 50.1
---------------- -----------------
Total Capitalization*........ 100.0% 100.0%
================ =================
* Total capitalization does not include as debt the present value of
PNM's operating lease obligations for PVNGS Units 1 and 2, EIP and
the Delta operating lease which was $184 million as of March 31, 2003
and $196 million as of December 31, 2002.
OTHER ISSUES FACING THE COMPANY
RESTRUCTURING THE ELECTRIC UTILITY INDUSTRY
State
In April 1999, the Restructuring Act was enacted into law. The
Restructuring Act would have opened the state's electric power market to
customer choice. On October 10, 2002, PNM announced that it had agreed with the
PRC Staff, the AG, and other consumer groups on a Global Electric Agreement that
provided for joint support to repeal a majority of the Restructuring Act, as
amended, a five-year rate path, procedures for the Company's participation in
wholesale plant activities and other regulatory issues. The Global Electric
Agreement was approved by the PRC on January 28, 2003. Legislation repealing the
Restructuring Act, as amended, and continuing the authorization for utilities to
participate in wholesale plant activities for a limited time was passed by the
New Mexico Legislature and signed into law by the Governor on April 8, 2003. In
the Global Electric Agreement, PNM agreed to forego recovery of the costs
incurred in preparing to transition to a competitive retail market in New
Mexico. This resulted in a charge of $16.7 million, pre-tax, in the first
quarter of 2003. As a result of the repeal of the Restructuring Act, PNM has
re-applied the accounting requirements of SFAS 71 to its regulated generation
activities effective January 28, 2003, which did not have a material effect on
the Company's financial condition or results of operations.
Federal
On April 11, 2003, the House of Representatives passed H.R. 6,
comprehensive energy legislation, which addresses numerous energy-related issues
including repeal of the Public Utility Holding Company Act ("PUHCA"), reform of
the Public Utility Regulatory Policy Act ("PURPA") and federal jurisdiction over
electric transmission. On April 30, 2003, the Senate Energy and Natural
Resources Committee reported out S. 14, the Energy Policy Act of 2003. The bill
contains an electricity title which among other things prevents the FERC from
issuing final rules on Standard Market Design prior to July 1, 2005, and
addresses RTO formation, comparable access on public power systems, native load
45
protections, market manipulation and PUHCA repeal. Because of the extensive
debate expected in the Senate, it is unknown when a vote on final passage may
occur. Differences between H.R. 6 and S. 14, if passed, would then be the
subject of conference committee discussions. The Company is unable to predict if
energy legislation will be passed or if passed, what form it will take, or if it
will be signed by the President if passed.
WATER SUPPLY
There is a growing concern in New Mexico about the use of water for power
plants, due to the state's arid climate and current drought conditions. The
availability of sufficient water supplies to meet all the needs of the state,
including growth, is a major issue. An interim committee of the legislature
refused to support legislation mandating the use of dry cooling technology.
Legislation requiring a water conservation plan as part of an application for
siting generation plants of a certain size was considered, but defeated, in the
2003 session. In building the Afton and Lordsburg plants, the Company has
secured sufficient water rights.
The Four Corners region, in which SJGS and Four Corners are located, has
been experiencing drought conditions that may affect the water supply for the
plants in 2003, as well as later years, if adequate moisture is not received in
the watershed that supplies the area. United States Bureau of Reclamation
("USBR") is working to assess the adequacy of the water supply under PNM's USBR
contract for 16,200 acre feet of water that supplies SJGS. Additionally, various
stakeholders in the San Juan Basin, including the New Mexico State Engineer, are
evaluating what water rights might be affected by the drought conditions,
including water rights pursuant to the New Mexico state permit that provide
8,000 acre feet of water to SJGS and approximately 28,000 acre feet of water for
Four Corners. In April 2003, a supplemental water supply contract was negotiated
between PNM and the Jicarilla Apache Nation to assist SJGS in meeting its water
requirement even if there is a water shortage. Certain environmental approvals
still need to be obtained in connection with this arrangement that will allow
PNM to use up to 10,000 acre-feet of the Jicarilla Apache Nation's reservoir
water if the USBR declares a shortage this summer. PNM does not believe that its
operations will be materially affected at this time. However, PNM cannot
forecast the weather situation and its ramifications with any degree of
certainty or how regulators and legislators may impact PNM's situation in the
future, should the drought continue.
WESTERN UNITED STATES WHOLESALE POWER MARKET
Various circumstances, including electric power supply shortages, weather
conditions, gas supply costs, transmission constraints, and alleged market
manipulation by certain sellers, resulted in the well-publicized "California
energy crisis" and in the bankruptcy filings of the California Power Exchange
("Cal PX") and of Pacific Gas and Electric Company ("PG&E"), although the
turmoil in the Western markets was not limited to California. However, since the
third quarter of 2001, conditions in the Western wholesale power market have
changed substantially as the result of regulatory actions, moderate weather
conditions, conservation measures, the construction of additional generation,
and a decline in natural gas prices, as well as the lingering slowdown in the
regional economy.
As a result of the foregoing conditions in the Western market, the FERC
and other federal and state governmental authorities are conducting
investigations and other proceedings relevant to the Company and other sellers.
The more significant of these in relation to the Company are summarized below.
46
California Refund Proceeding
By order dated June 19, 2001, in response to a complaint filed by San
Diego Gas and Electric Company ("SDG&E") and other California buyers against
sellers into the California wholesale electric market, the FERC directed one of
its administrative law judges ("ALJ") to convene a settlement conference to
address potential refunds owed by sellers into the California market. The
settlement conference, in which PNM participated, was ultimately unsuccessful,
and the ALJ recommended to the FERC that an evidentiary hearing be held to
resolve the dispute, suggesting that refunds were due; however, the estimated
refunds were significantly lower than those demanded by California, and in most
instances, were offset by the amounts due suppliers from the Cal PX and the
California Independent System Operator ("Cal ISO"). The California parties had
demanded refunds of approximately $9 billion from power suppliers. Hearings on
the refunds were held in September 2002 and the ALJ issued his Proposed Findings
on California Refund Liability on December 12, 2002, in which he determined that
the Cal ISO had, for the most part, calculated the amounts of the refunds
correctly. In his appendix identifying the amounts of the refunds, he identified
what he termed "ballpark" figures for the amount of refunds due under his order.
PNM was identified as having a refund liability of approximately $4.3 million,
while being owed approximately $7 million from the Cal ISO. Pursuant to the
FERC's order, PNM filed, in conjunction with the competitive supplier group,
initial comments on January 13, 2003 to the ALJ's preliminary findings
addressing errors the Company believes the ALJ made in his proposed findings and
reply comments on February 3, 2003. On March 26, 2003, the FERC issued an order
largely adopting the ALJ's findings, but requiring a change to the formula used
to calculate refunds, based upon concerns that the indices for California gas
prices, a major element in the formula, had been subject to potential
manipulation and were unverifiable. The effect of this change will be to
increase the Company's refund liability, although the precise amount will not be
known with certainty until the Cal ISO and Cal PX recalculate refund amounts
after the FERC has acted upon requests for rehearing that likely will be filed
by the parties.
In addition, prior to the December 12, 2002 ALJ decision, the Ninth
Circuit Court of Appeals ordered the FERC to allow the parties in the case to
provide additional evidence in the case concerning allegations of market
manipulation by sellers. Several California parties submitted additional
evidence on March 3, 2003, which they argue supports their position that
virtually all market participants either engaged in specific market manipulation
strategies or facilitated such strategies, including PNM. PNM maintains that it
did not engage in improper wholesale activities, and filed reply evidence on
March 20, 2003 denying the allegations against it. PNM cannot predict what
effect the FERC's review of this additional evidence will have on its rulings in
the refund proceeding or the determination of specific refund amounts. The
Company is unable to predict the ultimate outcome of this FERC proceeding, or
whether PNM will be directed to make any refunds as the result of a FERC order.
Pacific Northwest Refund Proceeding
In addition to the California refund proceedings, Puget Sound Energy,
Inc., ("Puget Sound") filed a complaint at the FERC alleging that spot market
prices in the Pacific Northwest wholesale electric market were unjust and
unreasonable. On September 24, 2001, the ALJ issued a recommended decision and
declined to order refunds associated with wholesale electric sales in the
Pacific Northwest. Prior to the FERC acting on the ALJ's recommended decision,
several parties joined in filing a motion at the FERC requesting the FERC to
reopen the proceeding, in view of the issuance of the FERC Staff's initial
report on the Enron trading strategies, to permit further investigation and
discovery into transactions in the wholesale electric market in the Pacific
Northwest. The FERC re-opened the docket to receive additional evidence from the
47
parties. The FERC did not remand the case to the ALJ, but determined to
undertake itself the review of any additional evidence in conjunction with the
ALJ's recommended decision. On March 3, 2003, Puget Sound and other parties
submitted additional evidence to the FERC alleging the existence of unlawful
wholesale electric prices in the Pacific Northwest and that the FERC should
require sellers to provide refunds for spot market bilateral sales transactions
in the Pacific Northwest. The Company believes there is nothing in this
additional evidence that requires the FERC to reverse the prior decision of the
ALJ denying refunds. At a recent open meeting, the FERC commissioners indicated
a willingness to order refunds for the period December 25, 2000-June 20, 2001,
based on their perceptions that California spot market prices were closely
linked to Pacific Northwest spot market prices during the relevant period.
However, the FERC has not yet issued an order requiring refunds. The Company is
unable to predict the ultimate outcome of this FERC proceeding, or whether PNM
will be directed to make any refunds as the result of an order by the FERC.
FERC Investigation of "Enron-Like" Trading Practices
The FERC has also initiated a market manipulation investigation,
partially in response to the bankruptcy filing of the Enron Corporation
("Enron") and to allegations that Enron may have engaged in manipulation of
portions of the Western wholesale power market. In connection with that
investigation, all FERC jurisdictional and non-jurisdictional sellers into
Western electric and gas markets have been required to submit data regarding
short-term transactions in 2000-2001. PNM made its data submission in April
2002. Subsequently, in May 2002, new Enron documents came to light that raised
additional concerns about Enron's trading practices. In light of these new
revelations, the FERC issued additional orders in the pending investigation
requiring sellers to respond to detailed questions by admitting or denying that
they had engaged in trading practices similar to those practiced by Enron and
certain other sellers, including so-called "wash" transactions. The FERC issued
supplemental requests for data submissions. In its responses to the FERC
requests, PNM denied that it had engaged in improper activities such as those
identified in Enron's memos and also denied engaging in "wash" transactions. PNM
admitted engaging in certain activities described in the memos that were not
improper. Where appropriate, PNM's responses addressed any arguable similarities
between any of its wholesale activities and those under investigation by the
FERC. In August 2002 the FERC staff issued a preliminary report on its findings,
recommending that the FERC initiate formal investigative proceedings directed at
three companies and the FERC has done so. The Company was not among the
companies named. On March 26, 2003, the FERC staff issued its final report,
which addressed various types of conduct that the FERC staff believes may have
violated market monitoring protocols in the Cal ISO and Cal PX tariffs. Based on
the final report, the FERC has issued orders to certain companies, including
Enron, requiring them to show cause why the FERC should not revoke their
authorizations to sell electricity at market-based rates. In addition, the FERC
staff has recommended that the FERC issue orders requiring certain entities to
show cause why they should not be required to disgorge profits associated with
conduct deemed to violate the Cal ISO and Cal PX tariffs, or be subject to other
48
remedial action. The FERC staff has recommended that PNM be one of the entities
required to show cause why it should not disgorge profits related to its
business dealings with Enron and Enron's employment of certain trading
strategies deemed to be manipulative. The scope of this recommendation is not
clear. The discussion of PNM in the final staff report relates to a proposed
business arrangement not entered into by PNM, but it is not clear whether a show
cause order, if issued, would also address routine market transactions between
PNM and Enron, or any other transactions. The FERC has not yet acted upon this
staff recommendation. The FERC also has invited parties to submit comments on
the FERC staff's analysis of the Cal ISO and Cal PX market monitoring protocols
and the FERC's authority to remedy purported violations of those protocols. The
Company cannot predict the outcome of this investigation.
California Power Exchange and Pacific Gas and Electric Bankruptcies
In January and February 2001, SCE and PG&E, major purchasers of power
from the Cal PX and Cal ISO, defaulted on payments due the Cal PX for power
purchased from the Cal PX in 2000. These defaults caused the Cal PX to seek
bankruptcy protection. PG&E subsequently also sought bankruptcy protection. PNM
has filed its proofs of claims in the Cal PX and PG&E bankruptcy proceedings.
Total amounts due PNM from the Cal PX or Cal ISO for power sold to them in 2000
and 2001 total approximately $7 million. The Company has provided allowances for
the total amount due from the Cal PX and Cal ISO.
California Attorney General Complaint
In March 2002, the California Attorney General filed a complaint with the
FERC against numerous sellers regarding prices for wholesale electric sales into
the Cal ISO and Cal PX and to the California Department of Water Resources ("Cal
DWR"). PNM was among the sellers identified in this complaint and filed its
answer and motion to intervene. In its answer, PNM defended its pricing and
challenged the theory of liability underlying the California Attorney General's
complaint. On May 31, 2002, the FERC entered an order denying the California
Attorney General's request to initiate a refund proceeding, but directed
sellers, including PNM, to comply with additional reporting requirements with
regard to certain wholesale power transactions. PNM has made filings required by
the May 31, 2002 order. The California Attorney General filed a request for
rehearing contesting the FERC decision. On September 23, 2002, the FERC issued
its order denying the California Attorney General's request for rehearing. The
California Attorney General has filed a petition for review in the United States
Court of Appeals for the Ninth Circuit. PNM has intervened in the Ninth Circuit
appeal and intends to participate as a party in that proceeding. The Company
cannot predict the outcome of this appeal. As addressed below, the California
Attorney General has also threatened litigation against PNM in state court in
California based on similar allegations.
California Attorney General Threatened Litigation
The California Attorney General has filed several lawsuits in California
state court against certain power marketers for alleged unfair trade practices
involving alleged overcharges for electricity. In April 2002, the California
Attorney General notified PNM of its intention to file a complaint in California
state court against PNM concerning its alleged failure to file rates for
wholesale electricity sold in California and for allegedly charging unjust and
unreasonable rates in the California markets. The letter invited PNM to contact
the California Attorney General's office before the complaint was filed, and PNM
has met several times with representatives of the California Attorney General's
office. Further discussions are contemplated. To date, a lawsuit has not been
filed by the California Attorney General and the Company cannot predict the
outcome of this matter.
49
California Antitrust Litigation
Several class action lawsuits have been filed in California state courts
against electric generators and marketers, alleging that the defendants violated
the law by manipulating the market to grossly inflate electricity prices. Named
defendants in these lawsuits include Duke Energy Corporation ("Duke") and
related entities along with other named sellers into the California market and
numerous other "unidentified defendants." Certain of these lawsuits were
consolidated for hearing in state court in San Diego. In May 2002, the Duke
defendants in the foregoing state court litigation served a cross-claim on PNM.
Duke also cross-claimed against many of the other sellers into California. Duke
asked for declaratory relief and for indemnification for any damages that might
ultimately be imposed on Duke. Several defendants removed the case to federal
court. The federal judge has entered an order remanding the matter to state
court, but the effect of that ruling has been stayed pending appeal. PNM has
joined with other cross-defendants in motions to dismiss the cross-claim. The
Company believes it has meritorious defenses but cannot predict the outcome of
this matter.
Block Forward Agreement Litigation
On February 1, 2002, PNM was served with a declaratory relief complaint
filed by the State of California in California state court. The state's
declaratory relief complaint seeks a determination that the state is not liable
for its commandeering of certain energy contracts known as "Block Forward
Agreements". The Block Forward Agreements were a form of futures contracts for
the purchase of electricity at below-market prices and served as security for
payment by PG&E and SCE for their electricity purchases through the Cal PX. When
PG&E and SCE defaulted on payment obligations incurred through the Cal PX, the
Cal PX moved to liquidate the Block Forward Agreements to satisfy in part the
obligations owed by PG&E and SCE. Before the Cal PX could liquidate the Block
Forward Agreements, California commandeered them for its own purposes. In March
2001, PNM and other similarly situated sellers of electricity through the Cal PX
filed claims for damages with the California state Victims Compensation and
Government Claims Board ("Victims Claims Board") on the theory that the state,
by commandeering the Block Forward Agreements, had deprived them of security to
which they were entitled under the terms of the Cal PX's tariff. The Victims
Claims Board filing was an administrative remedy that served as a mandatory
prerequisite to filing suit against the state for recovery of damages related to
the commandeering of the Block Forward Agreements. The Victims Claims Board
denied PNM `s claim on March 22, 2002. PNM filed a complaint against the State
of California in California state court on September 20, 2002 seeking damages
for the state's commandeering of the Block Forward Agreements and requesting
judicial coordination with the state's declaratory relief action filed in
February 2002 on the basis that the two actions raise essentially the same
issues. The California state court has stayed the proceedings through July 2003
pending resolution of certain related issues before the FERC.
Citizen Suit Under the Clean Air Act
By letter dated January 9, 2002, counsel for the Grand Canyon Trust and
Sierra Club (collectively, "GCT") notified PNM of GCT's intent to file a
so-called "citizen suit" under the Clean Air Act, alleging that PNM and
co-owners of the SJGS violated the Clean Air Act, and the implemention of
federal and state regulations, at SJGS. Pursuant to that notification, on May
16, 2002, the GCT filed suit in federal district court in New Mexico against PNM
50
(but not against the other SJGS co-owners). The suit alleges two violations of
the Clean Air Act and related regulations and permits. First, GCT argues that
the plant has violated, and is currently in violation of, the federal PSD rules,
as well as the corresponding provisions of the New Mexico Administrative Code,
at SJGS Units 3 and 4. Second, GCT alleges that the plant has "regularly
violated" the 20% opacity limit contained in SJGS's operating permit and set
forth in federal and state regulations at Units 1, 3 and 4. The lawsuit seeks
penalties as well as injunctive and declaratory relief. PNM filed its answer in
federal court on June 6, 2002, denying the material allegations in the
complaint. Both sides in the litigation have filed motions for partial summary
judgment and on May 9, 2003 the court held a hearing on all pending motions. At
the conclusion of the hearing, the court denied the summary judgment motions
relating to the opacity claims, meaning that the opacity issues will go to trial
on the merits. The court took under advisement the summary judgment motions
relating to the PSD issues, but indicated that a ruling on those issues would be
forthcoming prior to trial. A trial date on liability issues had been scheduled
on a trailing docket for June 2003 but at the May 9 hearing the court indicated
that the trial would be deferred until August 2003 at the earliest. Based on its
investigation to date, the Company firmly believes that the allegations are
without merit and PNM vigorously disputes the allegations. PNM has always
adhered and continues to adhere to high environmental standards as evidenced by
its ISO 14000 certification. The Company is, however, unable to predict the
ultimate outcome of the matter.
NATURAL GAS EXPLOSION
On April 25, 2001, a natural gas explosion occurred in Santa Fe, New
Mexico. The apparent cause of the explosion was a leak from a PNM gas line near
the location. The explosion destroyed a small building and injured two persons
who were working in the building. PNM's investigation indicates that the leak
was an isolated incident likely caused by a combination of corrosion and
increased pressure. PNM also cooperated with an investigation of the incident by
the PRC's Pipeline Safety Bureau (the "Bureau"), which issued its report on
March 18, 2002. The Bureau's report gave PNM notice of probable violations of
the New Mexico Pipeline Safety Act and related regulations. PNM and the Bureau
staff entered a compliance agreement addressing the probable violations and
filed it with the PRC for approval on March 4, 2003. PNM agreed to undertake a
list of twenty-four corrective actions, including internal policy changes,
retraining employees and enhancing gas line monitoring. PNM has also agreed to
voluntarily accelerate spending on pipeline replacement by more than $10.0
million and to commit an additional $1.8 million to development and
implementation of systems to improve gas line management. The compliance
agreement was approved by the PRC on March 25, 2003. No civil penalty was
imposed. Two lawsuits against PNM by the injured persons along with several
claims for property and business interruption damages have been resolved.
LANDOWNER ENVIRONMENTAL CLAIMS
In March 2002, a lawsuit was filed in New Mexico state court by a
landowner owning property in the vicinity of SJGS, against PNM and SJCC. The
complaint seeks $20 million in damages, plus pre-judgment interest and punitive
damages, based on allegations related to the alleged discharge of pollutants
into an arroyo near the plant, including damage to the plaintiff's livestock. A
jury trial has been demanded. PNM has denied the allegations of wrongdoing and
has vigorously defended this matter. After the court entered an order compelling
51
the plaintiff to answer PNM's discovery requests, the plaintiff filed a motion
to dismiss his lawsuit without prejudice. PNM responded that the dismissal
should be with prejudice and questions associated with dismissal will be
addressed at a court hearing scheduled for June 4, 2003.
PNM LABOR UNION NEGOTIATIONS
PNM and the International Brotherhood of Electrical Workers ("IBEW")
Local Union 611 entered into negotiations for a successor agreement during the
later part of the first quarter of 2003. The current collective bargaining
agreement, which covers the approximately 580 bargaining unit employees in
Electric Operations, expired on May 1, 2003. PNM and IBEW agreed to a 30-day
extension of the agreement, making the extended expiration date May 30, 2003.
During this time, PNM and IBEW will continue negotiations. In the event an
agreement is not reached by the extended expiration date, either party may then
terminate the agreement anytime thereafter by giving 30 days written notice.
While PNM believes that its relations with its employees are satisfactory, a
dispute between the Company and its employees' representative could have a
material adverse effect on PNM.
NEW AND PROPOSED ACCOUNTING STANDARDS
Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities", an interpretation of Accounting
Research Bulletin (ARB) No. 51, "Consolidated Financial Statements" ("FIN 46").
In January 2003, the FASB issued FIN 46 to address the consolidation of variable
interest entities that have one or both of the following characteristics: (1)
the equity investment at risk is not sufficient to permit the entity to finance
its activities without additional subordinated financial support from other
parties, which is provided through other interests that will absorb some or all
of the expected losses of the entity and (2) the equity investors lack one or
more of the following essential characteristics of a controlling financial
interest: (a) the direct or indirect ability to make decisions about the
entity's activities through voting rights or similar rights, (b) the obligation
to absorb the expected losses of the entity if they occur, which makes it
possible for the entity to finance its activities, or (c) the right to receive
the expected residual returns of the entity if they occur, which is the
compensation for the risk of absorbing the expected losses. FASB believes that
if a business enterprise has a controlling financial interest in a variable
interest entity, the assets, liabilities, and results of the activities of the
variable interest entity should be included in consolidated financial statements
with those of the business enterprise. FIN 46 requires existing unconsolidated
variable interest entities to be consolidated by their primary beneficiaries if
the entities do not effectively disperse risks among parties involved. There are
also additional disclosure requirements for an enterprise that holds significant
variable interests in a variable interest entity but is not the primary
beneficiary. FIN 46 applies immediately to variable interest entities created
after January 31, 2003, and to variable interest entities in which an enterprise
obtains an interest after that date and may be applied prospectively with a
cumulative-effect adjustment as of the date on which it is first applied or by
restating previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year restated. The
adoption of FIN 46 as of February 1, 2003, did not have a material impact on the
Company's financial condition or results of operations.
52
EITF 02-3 "Issues Related to Accounting for Contracts Involved in Energy
Trading and Risk Management Activities", EITF 98-10 "Accounting for Contracts
Involved in Energy Trading and Risk Management Activities" and Statement of
Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for Derivative
Instruments and Hedging Activities". On October 25, 2002, the EITF reached a
final consensus on EITF 02-3 that rescinds EITF 98-10 and requires that all
energy contracts held for trading purposes be presented on a net margin basis in
the statement of earnings. The rescission of EITF 98-10 requires that energy
contracts which do not meet the definition of a derivative under SFAS 133 no
longer be marked to market and recognized in current earnings. As a result, all
contracts which were marked to market under EITF 98-10 and must now be accounted
for under the accrual method should be written back to cost with any difference
included as a cumulative effect of a change in accounting principle in the
period of adoption. This transition provision was effective January 1, 2003. The
rescission of EITF 98-10 did not have a material impact on the Company's
financial condition or results of operations as all contracts previously marked
to market under the definition provided in EITF 98-10 also met the definition of
a derivative under SFAS 133 and are properly recorded at fair value with gains
and losses recorded in earnings. The Company reviewed its energy contract
portfolio to determine whether its contracts meet the definition of trading
activities under EITF 02-3. As a result, the Company has reclassified those
contracts previously accounted for under EITF 98-10 to a net margin basis for
the three months ended March 31, 2002. The Company will not report revenues and
cost of energy sold on a net margin basis on a prospective basis as a result of
the application of EITF 02-3 as none of the Company's marketing activities meet
the definitions of trading activities as prescribed by EITF 02-3.
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
Statements made in this filing that relate to future events are made
pursuant to the Private Securities Litigation Reform Act of 1995. Readers are
cautioned that all forward-looking statements are based upon current
expectations and are subject to risk and uncertainties. The Company assumes no
obligation to update this information.
Because actual results may differ materially from expectations, the
Company cautions readers not to place undue reliance on these statements. Future
financial results will be affected by a number of factors, including interest
rates, weather, fuel costs, changes in supply and demand in the market for
electric power, wholesale power prices, market liquidity, the competitive
environment in the electric and natural gas industries, the performance of
generating units and transmission system, state and federal regulatory and
legislative decisions and actions, and the performance of state, regional and
national economies.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company uses derivative financial instruments to manage risk as it
relates to changes in natural gas and electric prices, changes in interest rates
and, historically, adverse market changes for investments held by the Company's
various trusts. Additionally, the Company uses derivative instruments based on
certain financial composite indices as part of its enhanced cash management
program. The Company also uses certain derivative instruments for wholesale
power marketing transactions in order to take advantage of favorable price
movements and market timing activities in the wholesale power markets. The
following additional information is provided.
53
Risk Management
The Company controls the scope of its various forms of risk through a
comprehensive set of policies and procedures and oversight by senior level
management and the Holding Company Board of Directors. The Board's Finance
Committee sets the risk limit parameters. The Risk Management Committee ("RMC"),
comprised of corporate and business segment officers and other managers,
oversees all of the activities, which include commodity price, credit, equity,
interest rate and business risks. The RMC has oversight for the ongoing
evaluation of the adequacy of the risk control organization and policies. The
Company has a risk control organization, headed by the Director of Financial
Risk Management ("Risk Manager"), which is assigned responsibility for
establishing and enforcing the policies, procedures and limits and evaluating
the risks inherent in proposed transactions, on an enterprise-wide basis.
The RMC's responsibilities specifically include: establishment of a
general policy regarding risk exposure levels and activities in each of the
business segments; recommendation of the types of instruments permitted;
authority to establish a general policy regarding counterparty exposure and
limits; authorization and delegation of transaction limits; review and approval
of controls and procedures; review and approval of models and assumptions used
to calculate mark-to-market and risk exposure; authority to approve and open
brokerage and counterparty accounts; review of hedging and risk activities; and
quarterly reporting to the Finance Committee and the Board of Directors on these
activities.
The RMC also proposes Value at Risk ("VAR") limits to the Finance
Committee. The Finance Committee ultimately sets the aggregate VAR limits.
It is the responsibility of each business unit to create its own control
procedures and policies within the parameters established by the Finance
Committee. The RMC reviews and approves these policies, which are created with
the assistance of the Chief Accounting Officer, Director of Internal Audit and
the Risk Manager. Each business unit's policies address the following controls:
authorized risk exposure limits; authorized instruments and markets; authorized
personnel; policies on segregation of duties; policies on mark-to-market
accounting; responsibilities for deal capture; confirmation procedures;
responsibilities for reporting results; statement on the role of derivative
transactions; and limits on individual transaction size (nominal value).
To the extent an open position exists, fluctuating commodity prices can
impact financial results and financial position, either favorably or
unfavorably. As a result, the Company cannot predict with precision the impact
that its risk management decisions may have on its businesses, operating results
or financial position.
Commodity Risk
Marketing and procurement of energy often involves market risks
associated with managing energy commodities and establishing open positions in
the energy markets, primarily on a short-term basis. These risks fall into three
different categories: price and volume volatility, credit risk of counterparties
and adequacy of the control environment. PNM routinely enters into forward
contracts and options to hedge purchase and sale commitments, fuel requirements
and to enhance returns and minimize the risk of market fluctuations on the
Wholesale Operations.
54
The Company's Wholesale Operations, including long-term contracts,
forward sales and short-term sales, are managed through an asset-backed
marketing strategy, whereby PNM's aggregate net open forward contract position
is covered by its forecasted excess generation capabilities. PNM is exposed to
market risk if its generation capabilities were disrupted or if its retail load
requirements were greater than anticipated. If PNM were required to cover all or
a portion of its net open contract position, it would have to meet its
commitments through market purchases.
Under the derivative accounting rules and the related accounting rules
for energy contracts, the Company accounts for its various financial derivative
instruments for the purchase and sale of energy differently based on
management's intent when entering into the contract. Energy contracts which meet
the definition of a derivative under SFAS 133 and do not qualify for a normal
purchase or sale designation are recorded on the balance sheet at fair market
value at each period end. The changes in fair market value are recognized in
earnings unless specific hedge accounting criteria are met. Should an energy
transaction qualify as a hedge under SFAS 133, fair market value changes from
year to year are recognized on the balance sheet with a corresponding charge to
other comprehensive income. Gains or losses are recognized when the hedged
transaction settles. Derivatives that meet the normal sales and purchases
exceptions within SFAS 133 are not marked to market but rather recorded in
results of operations when the underlying transaction settles.
The following table shows the net fair value of mark-to-market energy
contracts included in the balance sheet:
March 31, December 31,
2003 2002
------------- --------------
(In thousands)
Mark-to-Market Energy Contracts:
Current asset...................................... $ 16,081 $ 4,531
Long-term asset.................................... 659 267
------------- --------------
Total mark-to-market assets................... 16,740 4,798
------------- --------------
Current liability.................................. (18,085) (5,725)
Long-term liability................................ - -
------------- --------------
Total mark-to-market liabilities.............. (18,085) (5,725)
------------- --------------
Net fair value of mark-to-market energy contracts.... $ (1,345) $ (927)
============= ==============
The mark-to-market energy portfolio positions at March 31, 2003 and
December 31, 2002 represent net liabilities after netting all open purchase and
sale contracts.
The market prices used to value PNM's mark-to-market energy portfolio are
based on closing exchange prices and broker quotations. As of March 31, 2003 and
December 31, 2002, PNM did not have any outstanding contracts that were valued
using methods other than quoted prices. The Company did not change its methods
for valuing its mark-to-market energy portfolio in 2003 as compared to 2002.
55
The following table provides detail of changes in the Company's
mark-to-market energy portfolio net asset or liability balance sheet position
from one period to the next:
Three Months Ended
March 31,
2003 2002
--------------- -------------
(In thousands)
Sources of Fair Value Gain/(Loss)
Fair value at beginning of year........... $ (927) $(30,440)
Amount realized on contracts delivered
during period.......................... 841 8,227
Changes in fair value..................... (1,259) 1,283
--------------- -------------
Net fair value at end of period........... $(1,345) $(20,930)
=============== =============
Net change recorded as mark-to-market..... $ (418) $ 9,510
=============== =============
The following table provides the maturity of the net assets/(liabilities)
of the Company, giving an indication of when these mark-to-market amounts will
settle and generate/(use) cash. The following values were determined using
broker quotes:
Fair Value at March 31, 2002
Maturities
---------------------------------------------------------
Less than
1 year 1-3 Years Total
------------------- --------------- -----------------
(In thousands)
$(1,904) $ 559 $ (1,345)
As of March 31, 2003, a decrease in market pricing of PNM's
mark-to-market energy portfolio by 10% would have resulted in a decrease in net
earnings of less than 1%. Conversely, an increase in market pricing of this
portfolio by 10% would have resulted in an increase in net earnings of less than
1%.
At March 31, 2003, the market value of PNM's normal sales and purchases
of electricity was a $47.6 million asset using the valuation methods described
above. If these transactions did not meet the definition of normal under the
accounting rules for derivatives, the Company would have recognized unrealized
losses of $7.1 million as an adjustment to wholesale operating revenues based on
the change in fair value of these contracts from January 1, 2003 to March 31,
2003.
The Company assesses the risk of these long-term contracts and wholesale
sales activities using the VAR method to maintain the Company's total exposure
within management-prescribed limits. The Company utilizes the
variance/covariance model of VAR, which is a probabilistic model that measures
the risk of loss to earnings in market sensitive instruments. The
variance/covariance model relies on statistical relationships to analyze how
56
changes in different markets can affect a portfolio of instruments with
different characteristics and market exposure. VAR models are relatively
sophisticated; however, the quantitative risk information is limited by the
parameters established in creating the model. The instruments being evaluated
may trigger a potential loss in excess of calculated amounts if changes in
commodity prices exceed the confidence level of the model used. The VAR
methodology employs the following critical parameters: volatility estimates,
market values of open positions, appropriate market-oriented holding periods and
seasonally adjusted correlation estimates. The Company's VAR calculation only
considers the Company's forward position for the preceding eighteen months. The
Company uses a holding period of three days as the estimate of the length of
time that will be needed to liquidate the positions. The volatility and the
correlation estimates measure the impact of adverse price movements both at an
individual position level as well as at the total portfolio level. The
two-tailed confidence level established is 99%. For example, if VAR is
calculated at $10 million, it is estimated at a 99% confidence level that if
prices move against PNM's positions, the Company's pre-tax gain or loss in
liquidating the portfolio would not exceed $10 million in the three days that it
would take to liquidate the portfolio.
The Company's VAR is regularly monitored by the Company's RMC. The RMC
has put in place procedures to ensure that increases in VAR are reviewed and, if
deemed necessary, acted upon to reduce exposures. The VAR represents an estimate
of the potential gains or losses that could be recognized on PNM's wholesale
power marketing portfolios given current volatility in the market, and is not
necessarily indicative of actual results that may occur, since actual future
gains and losses will differ from those estimated. Actual gains and losses may
differ due to actual fluctuations in market rates, operating exposures, and the
timing thereof, as well as changes to PNM's wholesale power marketing portfolios
during the year.
The Company accounts for the sale of electric generation in excess of its
retail needs or the purchase of power for retail needs as normal purchases and
sales under SFAS 133. Transactions that do not meet the normal purchase or sale
exception or the definition of a hedge under SFAS 133 are accounted for as
energy marketing contracts and comprise PNM's mark-to-market portfolio. The VAR
for the mark-to-market portfolio was $176 thousand at March 31, 2003. The
Company also calculates a portfolio VAR for the preceding 18 months, which in
addition to its mark-to-market portfolio includes all contracts designated as
normal sales and purchases, hedges, and its estimated excess generation assets.
This excess is determined using average peak forecasts for the respective block
of power in the forward market. The Company's portfolio VAR was $10.1 million at
March 31, 2003.
The following table shows the high, average and low market risk as
measured by VAR on the Company's mark-to-market portfolio:
Three Months Ended
March 31, 2003
Period
High Average Low End
---------- ------------ ------------ -----------
(In thousands)
Three day holding period, 99%
two-tailed confidence level....... $ 727 $ 168 $ 10 $ 176
One day holding period, 99%
two-tailed confidence level....... $ 420 $ 97 $ 6 $ 102
Ten day holding period, 95%
two-tailed confidence level....... $1,012 $ 235 $ 14 $ 245
57
Credit Risk
PNM is exposed to credit losses in the event of non-performance or
non-payment by counterparties. The Company uses a credit management process to
assess and monitor the financial conditions of counterparties. Credit exposure
is also regularly monitored by the RMC. The Company provides for losses due to
market and credit risk. PNM's credit risk with its largest counterparty as of
March 31, 2003 was $20.2 million.
In 2001, in response to the increased credit risk and market price
volatility described above, the Company provided an allowance against revenue of
$12.0 million for anticipated losses to reflect management's estimate of the
increased market and credit risk in the wholesale power market and its impact on
2001 revenues. As of December 31, 2001, $8.9 million was transferred to the
allowance for bad debt. Based on information available at March 31, 2003, the
Company believes the total allowance for anticipated losses (exclusive of bad
debt), currently established at $2.4 million, is adequate for management's
estimate of losses from credit risk. The Company will continue to monitor the
wholesale power marketplace and adjust its estimates accordingly.
The following table provides information related to PNM's credit
exposure, net of collateral as of March 31, 2003. It further delineates that
exposure by the credit worthiness (credit rating) of the counterparties and
provides guidance as to the concentration of credit risk to individual
counterparties PNM may have. Also provided is an indication of the maturity of a
company's credit risk by credit ratings of the counterparties.
Schedule of Wholesale Operations Credit Risk Exposure
March 31, 2003
Net
Exposure Number Exposure
Before of of
Credit Credit Counter- Counter-
Collateral Collateral Net parties parties
Rating (a) (b) (c) Exposure >10% >10%
- ------------------------- -------------- -------------- ------------- ---------- -------------
(Dollars in thousands)
Investment grade......... $43,867 $ - $43,867 2 $30,169
Non-investment grade 4,196 - 4,196 -
Internal ratings
Investment grade...... 249 - 249 -
Non-investment
grade............... 14,085 - 14,085 1 8,370
-------------- -------------- ------------- -------------
Total............ $62,397 $ - $62,397 $38,539
============== ============== ============= =============
Credit reserves $2,433
=============
(a) Rating - Included in "Investment Grade" are counterparties with a minimum
Standard & Poor's rating of BBB- or Moody's rating of Baa3. If the
counterparty has provided a guarantee by a higher rated entity (e.g., its
parent), determination is based on the rating of its guarantor. The
"Internal Ratings - Investment Grade" includes those counterparties that
are internally rated as investment grade in accordance with the
guidelines established in the Company's credit policy.
58
(b) The Exposure Before Credit Collateral is the net credit exposure to PNM
from its Wholesale Operations. This includes long-term contracts, forward
sales and short-term sales. The exposure captures the net amounts due to
PNM from receivables/payables for realized transactions, delivered and
unbilled revenues, and mark-to-market gains/losses (pursuant to contract
terms). Exposures are offset according to legally enforceable netting
arrangements. Amounts are presented before those reserves that are
determined on a portfolio basis. (See "Item 2. Management's Discussion
and Analysis of Financial Condition and Results of Operations - Western
United States Wholesale Power Market" for discussion of the reserves.)
(c) The Credit Collateral reflects the face amount of cash deposits, letters
of credit and performance bonds received from counterparties.
Maturity of Credit Risk Exposure
As of March 31, 2003
Exposure
Before
Less than Credit
Rating 2 Years 2-5 Years Collateral
- ------------------------- -------------- -------------- --------------
(In thousands)
Investment grade......... $29,980 $13,887 $43,867
Non-investment grade 4,196 - 4,196
Split rating............. - - -
Internal ratings
Investment grade...... 249 - 249
Non-investment
grade............... 14,085 - 14,085
-------------- -------------- --------------
Total............ $48,510 $13,887 $62,397
============== ============== ==============
Natural Gas Supply Contracts
PNM hedges certain portions of natural gas supply contracts in order to
protect its retail customers from adverse price fluctuations in the natural gas
market. The financial impact of all hedge gains and losses, including the
related costs of the program, is recoverable through the purchased gas
adjustment clause. As a result, earnings are not affected by gains and losses
generated by these instruments.
Interest Rate Risk
As of March 31, 2003 the Company has liquidated its investment portfolio
of fixed-rate government obligations and corporate securities. Due to the
settlement process of accrued income, the portfolio still holds a small amount
of cash and cash equivalent securities.
59
PNM has long-term debt which subjects it to the risk of loss associated
with movements in market interest rates. All of the Company's long-term debt is
fixed-rate debt, and therefore, does not expose the Company's earnings to a risk
of loss due to adverse changes in market interest rates. However, the fair value
of these debts instruments would increase by approximately 3.95% or $40.5
million if interest rates were to decline by 50 basis points from their levels
at March 31, 2003. As of March 31, 2003, the fair value of PNM's long-term debt
was $1,026 million as compared to a book-value of $954 million. In general, an
increase in fair value would impact earnings and cash flows if PNM were to
re-acquire all or a portion of its debt instruments in the open market prior to
their maturity. PNM currently has $46 million of tax-exempt bonds outstanding
that were callable at a premium beginning December 15, 2002, and an additional
$136 million that become callable at a premium in August 2003. To hedge against
the risk of rising interest rates and their impact on the economics of calling
the debt, PNM has entered into forward starting interest rate swaps in 2001 and
2002. These forward interest rate swaps effectively lock-in interest rates for
the notional amount of the debt that is callable at a rate of approximately
4.95% plus an adjustment for PNM's and the industry's credit ratings. At March
31, 2003, the fair market value of these derivative financial instruments was
approximately $21.0 million unfavorable to the Company.
In February and March 2003, PNM contributed a total of $20 million for
plan year 2002 to the trust for the Company's pension plan, and other post
retirement benefits. The securities held by the trusts had an estimated fair
value of $446 million as of March 31, 2003, of which approximately 27% were
fixed-rate debt securities that subject the Company to risk of loss of fair
value with movements in market interest rates. If rates were to increase by 50
basis points from their levels at March 31, 2003, the decrease in the fair value
of the securities would be 3.27% or $4.2 million. PNM does not currently recover
or return through rates any losses or gains on these securities; therefore, the
Company is at risk for shortfalls in its funding of its obligations due to
investment losses. However, the Company does not believe that long-term market
returns over the period of funding will be less than required for the Company to
meet its obligations.
Equity Market Risk
As discussed above under Interest Rate Risk, PNM contributes to trusts
established to fund its share of the decommissioning costs of PVNGS and pension
and other post-retirement benefits. The trusts hold certain equity securities as
of March 31, 2003. These equity securities also expose the Company to losses in
fair value. Approximately 63% of the securities held by the various trusts were
equity securities as of March 31, 2003. Similar to the debt securities held for
funding decommissioning and certain pension and other post-retirement costs, PNM
does not recover or earn a return through rates on any losses or gains on these
equity securities.
In 2001, the Company implemented an enhanced cash management strategy
using derivative instruments based on the Standard & Poor's 100, S&P 500, and
Nasdaq composite indices. The strategy is designed to capitalize on high market
volatility or benefit from market direction. An investment manager is utilized
to execute the program. The program is carefully managed by the RMC and has VAR
and stop-loss limits established. Trades are typically closed-out before the end
of a reporting period and within the same day of execution.
60
The enhanced cash management program utilizes a one-day VAR under the
variance/covariance model, with a two-tailed confidence interval of 99%. As of
March 31, 2003, the program had open positions with mark-to-market gains of
approximately $68 thousand and a VAR of approximately $805 thousand.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The Company's principal executive officer and principal financial officer
have concluded that the Company's disclosure controls and procedures, based on
their evaluation on April 24, 2003 of these disclosure controls and procedures,
are effective to ensure that material information relating to the Company,
including its consolidated subsidiaries, was made known to them by others within
those entities, particularly during the period in which the periodic reports are
being prepared.
(b) Changes in internal controls.
None.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Former Albuquerque Gas and Electric ("AG&E") Manufactured Gas Plant Site
On December 8, 1999, PNM received a letter from the New Mexico
Environment Department ("NMED") notifying PNM that it had been designated as a
"responsible person" under the New Mexico Water Quality Control abatement
regulations. PNM was directed to submit an abatement plan to investigate alleged
contamination detected in the vicinity of a former manufactured gas plant
("MGP") owned and operated by AG&E, predecessor to PNM in southeast Albuquerque.
The contamination identified in the December 8 letter was described as "tar" and
"Volatile Organic Compounds." PNM agreed to conduct voluntary abatement.
PNM submitted its voluntary stage 1 abatement plan to the NMED on August
31, 2000. By letter dated November 30, 2000, the NMED conditionally approved
PNM's voluntary stage 1 abatement plan. PNM submitted its voluntary stage 1
abatement plan report ("Report") on October 12, 2001. The Report confirmed the
presence of soil contamination at the site resulting from the operations of the
former MGP. By letter dated December 20, 2001, the NMED approved the Report and
directed PNM to submit a voluntary stage 2 abatement plan for corrective action
at this site. PNM submitted its voluntary stage 2 abatement plan on November 12,
2002 and selected a remedial alternative and contractor. By letter dated January
21, 2003, the NMED approved the voluntary stage 2 abatement plan. NMED has
indicated that groundwater does not appear to have been impacted by the former
MGP operations although groundwater beneath the site contains contaminants
consistent with known upgradient diesel sources.
61
Site remediation began on February 17, 2003. Soils at the site
contaminated with oil and tar-like materials have been excavated for treatment
and disposal at the Sunnyside Cogeneration Associates Power Plant located in
Sunnyside Utah. Residual contaminants below 15-feet were capped. Completion of
site remediation occurred in April 2003. A corrective action report will be
submitted to the NMED and its approval will be sought later this year. The
current property owner proposes to construct a two-story building at the site.
Landowner Environmental Claims
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Landowner Environmental Claims".
California Attorney General Complaint
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Other Issues Facing the Company - Western
United States Wholesale Power Market - California Attorney General Complaint".
California Antitrust Litigation
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Other Issues Facing the Company - Western
United States Wholesale Power Market - California Antitrust Litigation".
(Intentionally left blank)
62
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
3.1 Restated Articles of Incorporation of PNM Resources dated
February 22, 2002 (incorporated by reference to Exhibit
3.1 to the Company's Annual Report on Form 10-K for the
year ended December 31, 2001)
3.1.1 Restated Articles of Incorporation of PNM, as amended
through May 31, 2002 (incorporated by reference to Exhibit
3.1.1 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2002)
3.2 Bylaws of PNM Resources, Inc. with all Amendments to and
including February 18, 2003 (incorporated by reference to
Exhibit 3.2 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2002)
3.2.1 By-laws of PNM with All Amendments to and including May
31, 2002 (incorporated by reference to Exhibit 3.2 to the
Company's Report on Form 10-Q for the fiscal quarter ended
June 30, 2002)
10.40.1 First Amendment dated February 17, 2003 to PNM Resources,
Inc. Director Retainer Plan
15.1 Letter Re: Unaudited Interim Financial Information for PNM
Resources, Inc. and Subsidiaries.
15.2 Letter Re: Unaudited Interim Financial Information for
Public Service Company of New Mexico.
99.1 Chief Executive Officer Certification Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
99.2 Chief Financial Officer Certification Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
b. Reports on Form 8-K:
Report dated and filed April 10, 2003 pursuant to Item 5 of Form 8-K that the
Company reduced long-term debt, adding liquidity facility.
Report dated and filed April 22, 2003 pursuant to Item 5 of Form 8-K that the
Company was served with twenty lawsuits seeking damages for personal injuries
(and one death) allegedly caused by primary exposure to asbestos at the
Company's premises.
Report dated and furnished April 30, 2003 pursuant to Items 9 and 12 of Form 8-K
that the Company issued a press release announcing its unaudited results of
operations for the three months ended March 31, 2003.
63
Signature
- ---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
PNM RESOURCES, INC. AND
PUBLIC SERVICE COMPANY OF NEW MEXICO
--------------------------------------------------
(Registrant)
Date: May 15, 2003 /s/ Robin A. Lumney
--------------------------------------------------
Robin A. Lumney
Vice President, Controller
and Chief Accounting Officer
(Officer duly authorized to sign this report)
64
CERTIFICATIONS:
I, Jeffry E. Sterba, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PNM
Resources, Inc. and Public Service Company of New Mexico;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrants as of, and for,
the periods presented in this quarterly report;
4. The registrants' other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrants and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrants, including their
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrants' other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants' auditors
and the audit committee of each registrants' board of directors
(or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants'
ability to record, process, summarize and report financial data
and have identified for the registrants' auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants'
internal controls; and
65
6. The registrants' other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
May 15, 2003
/s/ Jeffrey E. Sterba
- ----------------------------------
Jeffry E. Sterba,
Chairman, President and
Chief Executive Officer
66
I, John R. Loyack, certify that:
1. I have reviewed this quarterly report on Form 10-Q of PNM
Resources, Inc. and Public Service Company of New Mexico;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrants as of, and for,
the periods presented in this quarterly report;
4. The registrants' other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrants and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrants, including their
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrants' disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrants' other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants' auditors
and the audit committee of each registrants' board of directors
(or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants'
ability to record, process, summarize and report financial data
and have identified for the registrants' auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants'
internal controls; and
67
6. The registrants' other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
May 15, 2003
/s/ John R. Loyack
- ----------------------------------
John R. Loyack,
Senior Vice President and
Chief Financial Officer
68